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6 Ways SMRT Corporation Ltd Might Change Under the New Rail Financing Framework

SMRT Corporation Ltd  (SGX: S53) made a key announcement last Friday.

The land transport firm proposed a sale of its rail business’s operating assets to Singapore’s government under the new rail financing framework (NRFF) and outlined how the business is about to change.

This development could be significant, since SMRT Corporation’s rail segment accounted for 52% of total revenue for the financial year ended 31 March 2016 (FY2016).

Here’re six ways the NRFF could change SMRT Corporation:

1. Emergence of asset-light model click here

2. Capital expenditures are likely to come down click here

3. Debt likely comes down too click here

4. Non-rail businesses are not expected to be affected

SMRT Corporation does not expect its non-rail business segments to be affected:

“The NRFF is not expected to affect SMRT’s other existing non-rail business areas. We will continue to develop our core competencies and seek new growth opportunities to deepen our rail engineering expertise, expand our road and rail transport operational footprint, and extend our commercial out-of-network reach.”

This could be important, as the non-rail businesses accounts for the bulk of SMRT Corporation’s operating profit. This is summarised in the graph below:

SMRT operating profit
Source: SMRT Corporation’s earnings report and annual report

The non-rail segment, as the name suggests, refers to the segments outside of Train Operations and LRT Operations.

5. New long-term licenses

SMRT Corporation operates under three existing licenses. The snippets below summarises the existing license agreements for the North South East West (NSEW) Line, the Circle Line (CCL), and the Bukit Panjang Light Rail Transit (BPLRT):

“SMRT Trains entered into a Licence and Operating Agreement dated 1 April 1998 with LTA which gave SMRT Trains the right to operate the NSEW Line for an initial period of 30 years from 1 April 1998 to 31 March 2028, with a possible extension for a further period of 30 years.

SMRT Trains also subsequently obtained a licence from LTA to operate the CCL Line for a period of 10 years from 4 May 2009 to 3 May 2019, with a possible extension for a further period of 30 years.

SMRT Light Rail, a wholly-owned subsidiary of SMRT Trains, entered into a Licence and Operating Agreement dated 25 October 1999 with LTA which granted SMRT Light Rail the right to operate the BPLRT Line for an initial period of 29 years from 6 November 1999 to 31 March 2028, with a possible extension for a further period of 30 years.”

Under the NRFF, SMRT Corporation will surrender the existing licences and obtain a new single NRFF licence for an initial term of 15 years. The proposed start date is 1 October 2016. There is a possible extension period of five years with the NRFF licence.

6. Risks and rewards are now shared

With the NRFF, SMRT Corporation will operate under a new structure in which risks and rewards are shared with the Land Transport Authority (LTA).

An EBIT (earnings before interest and taxes) margin range for SMRT Corporation has been set between 3.5% and 5%. In the event when SMRT Corporation’s EBIT margin crosses either threshold, there will be sharing of both the upside and downside with the LTA. This is described in the following statements by the company in the NRFF announcement:

“If SMRT Trains is able to generate profits above a certain threshold (EBIT margin in excess of 5%), LTA will share the upside via a tiered sharing arrangement (cap) incorporated in the licence charge, with a prescribed percentage of up to a maximum of 95% of the incremental EBIT margin exceeding 5%.

Conversely, the risk-sharing features of the cap and collar also calibrate the licence charge payable to LTA (collar). When the overall EBIT margin falls below 3.5%, 50% of the shortfall will be borne by LTA. As mentioned in the immediately preceding sub-paragraph, LTA’s sharing of these downside risks is limited to the quantum of the licence charge payable for the financial year.”

The EBIT margin will be a composite of fare and non-fare operations. The non-fare operations consists of advertising and rental. Based on its latest annual report, I summarised SMRT Corporation’s EBIT margin by rail and non-rail operations below:

SMRT EBIT margin
Source: SMRT Corporation’s annual report

The non-rail margin here covers the non-fare segment. SMRT Corporation highlighted that there is no guarantee that the firm will achieve the stated EBIT threshold of 5%. As investors, we will have to watch for developments after 1 October 2016, if the deal goes through.

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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 contributor Chin Hui Leong doesn’t own shares in any companies mentioned.