ComfortDelGro: A Sustainable Dividend Play For Passive Income

Since the sneak preview of our upcoming series of focus lists, a flurry of preparatory work has been set in motion as we plough through more than 700 SGX-listed stocks looking for suitable candidates. While the lists have yet to be finalised, we're excited to unveil the first of several stocks that have already made the cut on our 'income' focus list, which will feature an array of dividend-paying stocks that may appeal to investors looking to generate a regular stream of dividend income from their stock holdings. At a forecasted 4.66% this year (as of 27 June 2017), ComfortDelGro's (SGX.C52) appetising dividend yield is certainly a head-turner, but with its taxi business facing a rough and bumpy road ahead, how safe are ComfortDelGro's dividends? Here are some reasons why we think ComfortDelGro could be a sustainable dividend play for income investors.

1. Fairly Sustainable Dividend Growth Track Record

As dividends are one of the primary drivers behind long-term stock returns, stocks that pay out progressively increasing dividends magnify the very strong compounding effect of reinvesting dividends. ComfortDelGro has an impressive track record of paying out dividends to its shareholders since 2003. In the aftermath of the global financial crisis that took place over 2007 – 2008, the company has also remarkably grown its dividends year after year (Chart 1). While past performance is not necessarily indicative of future results, ComfortDelGro's strong dividend growth track record, coupled with its clear policy of paying out at least half of its profits as dividends, signals the firm's commitment to reward shareholders continually.

Chart 1: Impressive Dividend Growth Track Record

ComfortDelGro's pace of dividend increase also looks fairly sustainable at the moment, given that the company's profits have been more than sufficient to support its dividend payments. Its pay-out ratio over the years has fluctuated between 50 – 70%, giving shareholders an adequate return on their investment, while also providing a safety buffer in the event of a sustained downturn in profitability. ComfortDelGro's pay-out ratio of close to 70% in 2016 implies that it will take at least a -30% plunge in profits before its current dividend per share of SGD 0.103 becomes unsustainable.

It is also worth noting that ComfortDelGro has been able to generate positive free cash flows to equity, which were more than sufficient to support its dividend pay-outs over the years, although investors may understandably be concerned over the inadequacy of ComfortDelGro's cash flows, albeit positive, to cover its dividends in 2015 and 2016, due to high capital expenditures and substantial debt repayments. This is likely to improve over the next few years, with market participants expecting ComfortDelGro's increased dividends to be supported sufficiently by its cash flows, especially with the transition to the new bus contracting model (more on that later), which will provide a boost to operating cash flows over the next few years.

2. Balance Sheet Strength Safeguards Shareholders From Dividend Cuts

Any fears of a potential dividend cut should be further allayed by ComfortDelGro's robust balance sheet, with a net cash position since 3Q 2015 and strong short-term liquidity, courtesy of its cash flow generation prowess. Its total cash on hand as of end March 2017 totalled SGD 639.2 million, an amount that is more than sufficient to cover its estimated capital expenditure of SGD 327.3 million this year, as well as SGD 254.4 million in short-term debt. Its current ratio of 1.04 is also indicative of ComfortDelGro's ability to meet its short-term obligations with ease.

ComfortDelGro's net debt-to-equity ratio of -8.11 and interest coverage ratio of 32.1 also compare favourably to that of most of its other local transportation peers, as well as regional players in developed Asia Pacific (Table 1). Given its sound financial position, ComfortDelGro is unlikely to slash its dividend anytime soon, with its healthy balance sheet also providing plenty ammunition for overseas acquisitions to supplement growth and further expand its footprint into other geographical markets beyond the shores of Singapore.

Table 1: Prudent Financial Management Reflected In Balance Sheet Strength

3. Bright Spots Amid Headwinds

While ComfortDelGro saw its net profit jump 12.4% year-on-year to SGD 82.5 million in 1Q 2017, the better-than-expected earnings was due to a special dividend from its stake in Cabcharge Australia, and belied a challenging operating environment for the transport giant as underlying revenue slid -2.4% year-on-year, while operating profits fell -8.1% year-on-year. Its taxi business was the main drag on earnings in absolute terms, with operating profits from this segment plunging by SGD -19.1 million from 1Q 2016, and is likely to remain under pressure given the stiff competition from private car operators Grab and Uber. Nonetheless, there are still reasons to be optimistic over ComfortDelGro's future prospects.

Its public transport segment, which brought in 56.8% of the firm's total revenue in 2016 and is operated by subsidiary SBS Transit (SGX.S61), is expected to be a future growth driver and could help pick up some of the slack. The opening of the much-anticipated Downtown Line 3 (DTL3), slated on 21 October 2017, will help to boost the bottom line of ComfortDelGro over the next few years. The line will run through some of Singapore's most populated areas, like Bedok and Tampines, and average daily ridership is forecasted at 500,000 – slightly more than double the current 245,000. The upcoming Thomson-East Coast Line could also be a potential catalyst for the stock, if ComfortDelGro clinches the tender for the operating license, with SMRT being its only other competitor.

The transition to the new bus contracting model (BCM) is also expected to be a positive for ComfortDelGro. Under the BCM, a total of 14 bus service packages will be tendered out gradually, with operators paid a fee to operate the services, while fare revenue will be retained by the government. While the bus industry overhaul is likely to threaten the existing duopoly dominated by SBS Transit and SMRT Buses, it is worth noting that bus operations have been running at low profitability under the previous model (Chart 2), and the BCM could bring about more sustainable margins. Despite losing out in the first two tenders, SBS Transit has managed to snag the Seletar bus package worth SGD 480 million for a five-year period starting from 1Q 2018. The rest of the 11 packages, 8 of which are operated by SBS Transit, will remain with the incumbents under the BCM, from which SBS Transit is expected to receive an estimated SGD 5,322 million, which will further improve ComfortDelGro's cash flows.

Chart 2: Low Profitability Of Bus Operations Under Previous Model

The headwinds faced by ComfortDelGro's taxi business, coupled with the transition into an asset-light model for its public transport business, means that earnings are likely muted this year, with a forecasted 1.6% earnings growth. That said, earnings are expected to catch up over the next few years, as ridership ramps up on DTL3 and bus profitability improves, with earnings growth in 2018 and 2019 expected to be 4.7% and 3.8% respectively.

4. Share Price Weakness Offers Buying Opportunity

ComfortDelGro's stock has taken quite a harsh beating in recent times. After rising to SGD 2.77 in May this year, its shares subsequently tanked -14.8% to its current price of SGD 2.36 (as of 27 June 2017) as first quarter earnings revealed further weakness in its taxi business. As ComfortDelGro pays regular dividends to its shareholders, the dividend discount model can be used to estimate its intrinsic value. Assuming a discount rate of 6.0% (calculated using the capital asset pricing model) and a constant dividend growth rate of 2.1% (assuming dividends grow in line with long-run inflation expectations), the simplified model yields an estimated target price of SGD 2.83 (Chart 3), which seems to suggest that ComfortDelGro may be undervalued at its current price.

Chart 3: Using The Dividend Discount Model To Estimate Intrinsic Value

Based on its last traded price, ComfortDelGro trades at a forward price-to-earnings (PE) ratio of 15.2X respectively. By way of comparison, its long-time rival SMRT Corporation was taken private last year by Temasek Holdings at an offer price of SGD 1.68 per share, which was 24 times its trailing 12-month earnings prior to the privatisation. ComfortDelGro also appears to be trading at a discount to the 16.3X peer average, as well as its own long-term average PE ratio of 15.6X. Based on its forward earnings per share of SGD 0.15 and PE ratio of about 18.5X, which is one standard deviation above its long-term average, ComfortDelGro's intrinsic value is estimated to be SGD 2.78, representing a potential upside of about 17.8%. As such, its valuations do not appear to be demanding at this moment.

Can ComfortDelGro Survive The Uber-Grab Onslaught?

The writing has been on the wall for quite some time. Since the advent of Uber and Grab, the population of private-hire cars plying Singapore's roads have soared by nearly 70 times to the current 41,297, outnumbering the 26,476-strong local taxi fleet (of which ComfortDelGro owns 15,863). With the sheer number of promo codes dished out every now and then, it's not difficult to see why commuters are slowly making the switch. While we acknowledge that ComfortDelGro's taxi business has certainly been impacted, it is not as bad as market participants make it out to be. Firstly, the average daily taxi ridership in Singapore has held up well, with ridership declining only by a mere -0.3% every year since Uber and Grab entered the market in 2013 (Chart 4).

Chart 4: Average Daily Taxi Ridership Has Held Up Well

Secondly, the disruptors themselves are disrupted by the government's move to tighten regulations on private-hire car drivers, requiring them to be licensed before they can drive with either Uber or Grab. Besides, private-hire cars are prohibited from doing street hails or taxi stand pick-ups, both of which are still sources of demand. Here's an interesting fact: all private-hire cars must now be affixed with an LTA-issued decal at nine designated inspection centres, seven of which are owned by ComfortDelGro's subsidiary, VICOM (SGX.V01).

Thirdly, it remains to be seen if Uber and Grab's low-cost strategy is sustainable in the long-term. Uber and Grab are both bleeding money, lots of it, and are kept alive only by the deep pockets of their investors. With its fleet of full-time drivers (private-hire car drivers are mostly part-timers), strong track record and financial resources, ComfortDelGro can certainly mount a credible challenge to Uber and Grab. Its own booking app is also now equipped with the flat fare option, which further simplifies its fare structure and provides commuters with more certainty on the cost of their rides.

Spread Your Investments Over Multiple Stocks!

For investors who may understandably be concerned over ComfortDelGro's recent stock price weakness, they can implement a dollar-cost averaging strategy by taking up small positions at regular intervals over-time, allowing them to purchase increasing amounts at cheaper prices, which could translate to higher returns when the stock eventually recovers. The minimum lot size is after all, just 100 shares. Investors can also lower their risk by diversifying their stock portfolios. Diversification helps to protect their portfolios from the effects of any one market trend, event or setback, and reduces the impact of being wrong on any one stock.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities. The analyst who produced this report has a position in ComfortDelGro.

The Research Team is part of iFAST Financial Pte Ltd.