With the threat of a recession looming, investors are turning to recession-proof companies that can continue raking in the profits. This is where Singapore’s pre-eminent land transport operator SBS Transit Ltd (SGX: S61) comes in.
The group, which is majority-owned by Comfortdelgro Corporation Ltd (SGX: C52), operates public bus and rail services in Singapore. Here is why I believe SBS has a business that is likely to thrive even if a full-blown recession hits.
Understanding the business
The public bus service in Singapore has recently been changed to a bus contracting model (BCM). In this model, operators bid to run a package of public bus services in Singapore. As of June 2019, there are 14 such bus packages, with SBS Transit Ltd running nine of these.
In the BCM model, SBS is paid an annual service fee for each public bus package. The Land Transport Authority, on the other hand, owns the assets, and retains passenger fares.
Because of the switch to the BCM, SBS has been able to transition to an asset-light business, as it does not need to buy new buses and has also leased its existing fleet of 2,900 buses to LTA at a lease price that is linked to depreciation.
Since the LTA switched to the BCM, SBS has seen its earnings skyrocket, while its cash flow has been much better as the company does not need to constantly purchase new buses.
Although SBS also has a rail and advertising arm, the revenue from the bus packages make up the bulk of its profits.
A recurring income stream
The eight BCM contracts initially signed by SBS in 2016 were also fairly long contracts, with an average span of seven years. These contracts will provide SBS with visible revenue and income for another few years. But what happens after these contracts expire?
In the BCM, bus operators are able to openly bid for bus packages that have expired or are newly released by LTA. When SBS Transit’s nine bus packages with the LTA expires, SBS will have to bid and compete with other bus operators.
However, SBS has built up a brilliant track record for operating the public bus system in Singapore. As such, I believe there is a fair amount of goodwill between the company and the LTA.
In 2018, SBS won the Bukit Merah bus package in a public tender. The Bukit Merah package was previously operated by SBS but was the first of the eight bus packages to expire.
Although SBS did not make the lowest offer, LTA still picked SBS to operate the Bukit Merah bus package. LTA said that its emphasis is on quality over price and said that SBS demonstrated innovative IT solutions for infrastructure and asset maintenance.
Although there is a chance that SBS will not be able to renew some of its bus packages when they expire, its track record with the LTA puts it in a commanding position when the public tenders are launched.
The Foolish bottom line
Due to the long-term nature of the current BCM contracts, SBS has visible income for the next few years at least. Furthermore, the initial batch of BCM contracts had service fees that were indexed to cost. As such, SBS will manage to retain its profit margins even in a shrinking economy.
SBS also has been a reliable operator of the public bus system in Singapore. LTA will likely keep that in mind when offering bus package contracts in the future. As such, it is very likely that SBS will be able to win more bus packages or retain its existing packages when they expire and are put up for tender.
All of which make SBS a defensive company that will likely continue to thrive in a recession.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia does not own shares in any of the companies mentioned. The Motley Fool Singapore has recommended shares of SBS Transit Limited.