Are The Worst Days Of SMRT Corporation Ltd Finally Behind It Now?

It was nearly one year ago when transport operator SMRT Corporation Ltd’s (SGX: S53) shares fell to S$1.01, a level last seen in 2006.

Since then though, the tide has turned.

The government had announced a new Public Bus Service Model last year which would allow operators to have an asset-light business model; SMRT was given an approval to raise its fares; and there had even been an improvement in the company’s earnings over the last few quarters.

These positive changes were warmly greeted by the market as SMRT’s shares have spiked by more than 60% since March 2014.

With all that as a backdrop, are the worst days of SMRT finally behind it? If so, does it mean that there is more room to climb for SMRT’s shares in the future even after that impressive 60% gain? Let’s take a look.

A case for a brighter future

Looking back at the history of SMRT, it should be noted that the firm had generated an average annual return on equity of around 20% from FY2004 (fiscal year ended 31 March 2004) to FY2011.

Over the past 12 months, SMRT’s return on equity is only 10.7%. If we assume that some form of mean reversion would take place and that SMRT would be able to pull its return on equity up to the 20% mark again, that might mean a significant jump in earnings for the company sometime in the future.

If that is the case, there’s a high chance that the value of the company might increase as well.

A story for a bleak outlook

However, there is a flip side to this story.

What if SMRT’s high returns on equity in the FY2004-FY2011 period had been the result of artificially-boosted earnings that came about from the firm delaying capital spending and maintenance works?

If that is the case, a return on equity of near-20% may not be a sustainable at all for the firm and we may want to expect the firm’s stable long-term return on equity to be somewhere in the neighbourhood of what we’re currently seeing.

With SMRT trading at an elevated price-to-earnings ratio of 29 (based on its earnings over the past 12 months) at its current share price of S$1.62, there might not be much further returns for investors to enjoy if the company is not able to grow its earnings significantly in the future.

Foolish Summary

I’ve just laid out one argument each for how SMRT’s shares may or may not have more room to climb in the future and it’s up to you to decide which story fits.

But regardless of whether you’re optimistic or pessimistic about SMRT’s prospects, it’s worth pointing out that the company’s providing a vital service in Singapore and so, it’d likely be around for many decades to come. That being said, having the ability to just survive and having the ability to flourish are two completely different things – we’d have to keep that in mind.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any companies mentioned above.