Public Transport Companies --- a good buy?

I read the recent articles on Singapore public transport with both interest and concern, especially on the recent fare hike and restructuring. Public transport is meant for the mass and providing the services at a 'reasonable' and 'affordable' rate should be the main objective for their existence.

Many blog posts and articles were already dedicated to this topic, debating and questioning the need for the increase. I'll hence look at public transport issue from a different angle i.e. investment grade of the public transport companies.

Monopoly?

Valuation

No complex analysis or elaborate ground survey is required for one to conclude that the local transport companies, SMRT and SBS Transit operate in near monopoly in their respective fields, namely rail and bus services. Elimination of service duplication (waste of resources) is the rationale behind the seemingly lack of competition, e.g. removal of bus service once the train starts to run.

If so, aren't these companies a good buy? The following are the litmus test, valuation ratios for SBS and SMRT:

SBS

• P/E: 12.3
• Rolling P/E: 15.3
• P/B: 2.5

SMRT

• P/E: 20.2
• Rolling P/E: 19.9
• P/B: 4.2

A moderately high P/E (above 10) and P/B (above 2) do suggest this from a valuation point of view. i.e. the market could price these with monopolistic premium.

Financial Performance

How about their financial performance? Do they perform as well as a typical monopoly (my criteria) does? i.e.

• high profit margin (>10%)
  
• good profit growth annually (>10%)
• respectable ROE (>20%)
  

The following table list the financial performance of the last 3 financial years for SBS and SMRT:

A few conclusions can be reached almost immediately by looking at the table above:

1. Firstly, SBS's financial performance pales badly compared to SMRT.
2. SBS's profit margins are below 10 and deteriorating while SMRT's improving and way above 15%.
3. SBS transits operating expenses rose more than twice as fast as SMRT.
   
4. Other than SBS's improving ROE, all its key financial ratios fail to make the grade for a monopoly.
5. SMRT performed far better. All the key ratio made the grade.
6. Perhaps that's the reason why they trade at almost twice as expensive as SBS (i.e. 4.2 times book value versus 2.5 for SBS)
7. Direct government grant (in the various forms to offset asset purchases, trains & buses) as a percentage of earnings is extremely low for SBS as compared to SMRT.
   

Investment grade analysis

At first glance, SMRT might seem to make investment sense. Looking at the financials results, SMRT are able to achieve record profits year after year with commendable ROE (20's) and profit growth (~10%).

However, things are not rosy as it seems. It could not raise fares as it like. Possibly due to its performance, its fare increases were not approved by Public Transport Council (PTC) while that of SBS were mostly approved. This is the characteristic of a regulated industry.

Looking at their financials and fare approvals/disapprovals by PTC, it seems to me that there is downside protection for both companies. i.e. it is almost impossible to make loss, this is because the companies can be sure to pass on rising business cost to the consumer should the former threaten the bottom line. On the other hand, there is a ceiling to their upside. There is a fare adjustment cap forumula to regulate the fares.

Short Term Outlook

Both companies operate in a tightly regulated industry with SMRT performing obviously better. As a defensive play where the investor is more concerned whether a company will risk bankrupcy, he can definitely sleep well owning SMRT.

Long Term Outlook

A check on the Land Transport Masterplan shows many changes affecting public transport in the coming decade. While SBS and SMRT are expected to continue their existence, by virtue of operating in a tightly regulated, non-competitive industry means that whether they could thrive or die will depend almost solely on the transport policy in the future. Gambling was never legal in Singapore in the past. Two casinos will be ready in the next few years. No one can tell the future.

Conclusion

Public transport is meant for the general public. Keeping it afforable is one of the main objective for the regulators. But to the transport companies, being listed stipulates them to maximises profit for their shareholders. How they manage these conflicting interest will always be a thorny issue.