Local stocks underwent a technical correction on 11 August as tensions in the Korean Peninsula continued to mount. The local barometer, Straits Times Index, plunged 1.3 percent on that particular Friday, as the “war of rhetoric” between US President Donald Trump and North Korean Leader Kim Jong Un prompted investors to take money off the table.

But amidst the escalating geopolitical tensions, there are some local counters that bucked the downtrend. Amongst them, SBS Transit (SBS) rose 2.7 percent to close at $2.66 after delivering a positive earnings surprise this result season. It is like a fitting reminder to investors that came in timely – play defensive when you are uncertain.

This is especially true in the current circumstance as the volatility index (VIX) – or commonly known as the “fear” index – is at its highest level since the beginning of the year. Taking cue from the VIX, the prevailing “fearful” sentiments suggest that any further escalation of tensions could potentially lead to a major correction for global stocks.

That said, we look at our local-listed public transport operator SBS Transit (SBS) and see why investors can include this counter to enhance the defensiveness of their portfolio.

Reliance On Public Transport

Public transport has been a basic necessity in Singapore where most common folks cannot afford a private car that comes with an exorbitant price tag. Data from the Land Transport Authority (LTA) detailed that there were only 544,638 motor cars as at July 2017, which translates to about just 9.8 percent of Singapore’s population. In order words, we can assume that more than 90 percent of Singaporeans depend on the public transport to commute.

In addition, commuting is a fundamental aspect of daily lives which makes SBS’s business one that is not subjected to cyclicality and hence inherently recession-proof. Furthermore, SBS is well-protected under Singapore’s oligopolistic public transport structure, where there are only four licensed public bus operators.

Bus Contracting Model Benefiting SBS

That said, in 2016, the Singapore government introduced the “bus contracting model” (BCM), which the industry has fully migrated to since September 2016. Under this framework, the government “took over” all ownerships of public bus infrastructures such as depots, buses, fleet management system and interchanges. Bus operators will instead bid for the rights to operate these services. In return, the LTA pays the operators a leasing fee based on the depreciation of the assets while the government retain the fares collected from commuters.

The new model is expected to promote competition and efficiency among the operators but competition is still confined between the four existing incumbents – lest for the time being. Moreover, the transfer of ownership of operating assets to the government will also help bus operators as non-cash depreciation charges become positive cash inflows from the fees received. Furthermore, the contract fee payable excludes adjustments for inflation, changes in wage level, fuel costs and other variable costs.

Meanwhile, bus operators themselves are allowed to keep the lucrative advertising and rental revenue from their bus operations. As a result, SBS being the largest bus operator in Singapore stand to gain the most from a more profitable industry.

TERMINAL

Also A Train Operator

Not to be confused with delisted-SMRT Corporation, SBS is also a railway operator in Singapore as well. The company operates the mass rapid transit (MRT) in the North East Line and the Downtown Line (DTL), as well as the light rail transit (LRT) of the Sengkang LRT and Punggol LRT. SBS retains all fare revenue from its rail services.

Whilst Singaporeans may be getting frustrated with the number of disruption incidents of our MRT system, we see more severe and frequent disruptions in SMRT-operated lines instead. Notwithstanding that, SBS is also seeing rising ridership from its rail services where the average daily ridership is nearing one million commuters.

In the short-term, we believe SBS will see a spike in ridership as the third phase of DTL is expected to commence revenue service on 21 October 2017. The latest phase will gradually see the addition of 16 connecting DTL stations.

(Source: SBS Transit)

(Source: SBS Transit)

Financial Performance

Even during the Asian financial crisis of 1997 and US subprime crisis of 2007, SBS still managed to generate positive earnings hence showcasing its resilience. In fact, the company had not posted any negative earnings in the past 20 years.

Zooming in to the last five financial years FY12 to FY16, revenue has grown from $792.3 million past the billion dollar mark to $1.1 billion. Despite that, profitability waned from FY12 to FY15 before growth finally returned in FY16. At a glance, however, SBS’s net profit still increased from $18.6 million in FY12 to $31.4 million in FY16.

In the latest 1H17 result, SBS reported revenue that increased 7.4 percent to $571.2 million while net profit rose 49.6 percent to $22.9 million. Stronger profitability was attributed to the transition to the BCM and higher ridership for its rail services. SBS further expects revenue to rise with the full year contribution of revenue under the BCM and commencement of phase three of DTL.

Where The Future Lies

Faster development and adoption of driverless technology will be where SBS future lies. Currently, under the BCM, staff costs have increased 10.7 percent to $309.4 million in 1H17 following the salary adjustments and increments hence making it the largest expense component at 54.2 percent of revenue.  Owing to the fact that SBS expects staff costs to continue rising, driverless technology may help SBS find significant savings in staff costs and give boost to its profitability in the future.

This is especially so under the BCM framework because LTA will incur the higher depreciation charges of autonomous buses than conventional buses. With an increasing number of automotive manufacturers declaring their ambitious plan to roll out autonomous driving vehicles by 2020s, we may just see this phenomenon coming to fruition sooner than expected.

Valuation

Since the beginning of the year, shares of SBS have rallied by about 25.5 percent to $2.66 per share. At the current share price, SBS is trading at a price-to-earnings multiple of about 21.2 times and price-to-book multiple of 1.9 times.

While the current share price does not appear cheap, SBS is now trading about four percent below its 52-week high of $2.77. The company has declared an interim dividend of $0.0365 per share, 55.3 percent higher than the previous interim dividend of $0.0235 declared a year ago. Based on trailing 12-months basis, SBS shares now offer a dividend yield of 2.3 percent.

Given its investment moat being the largest operator in the oligopolistic public bus transport system and coupled with a more profitable industry outlook, SBS may just fit the appetite for risk-averse investors.

SBS Double Decker In 1980s

(Source: SBS Transit)

(Source: SBS Transit)