MTR Corporation - - Credit Suisse

MTR Corporation - - Credit Suisse

19 June 2012 Asia Pacific/Hong Kong Equity Research Conglomerates MTR Corporation (0066.HK / 66 HK) Rating NEUTRAL* Price (15 Jun 12, HK$) 25.25 Targ...

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MTR Corporation Limited (“the Company”) is a publicly-listed company (SEHK: 0066) headquartered in the Hong Kong Spe

19 June 2012 Asia Pacific/Hong Kong Equity Research Conglomerates

MTR Corporation (0066.HK / 66 HK) Rating NEUTRAL* Price (15 Jun 12, HK$) 25.25 Target price (HK$) 25.64¹ Upside/downside (%) 1.5 Mkt cap (HK$ mn) 146,106 (US$ 18,829) Enterprise value (HK$ mn) 156,708 Number of shares (mn) 5,786.38 Free float (%) 22.8 52-week price range 28.0 - 22.8 *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months.

Research Analysts Cusson Leung, CFA 852 2101 6621 [email protected] Joyce Kwock 852 2101 7496 [email protected]


Ticket to a private party ■ Government should privatise MTR: the case. The upcoming review of the FAM between MTR and the government may arouse allegations that it is a potential connected transaction in substance, with minority shareholders being left out of the decision-making process. In view of the increasing focus on corporate governance, we believe that one of the best options for the government is to privatise MTR in order to minimise the impact to minority shareholders and sooth the social pressure on the fare adjustment issue. In such a scenario, we estimate there is about 27% upside to the stock.

■ Breach of the FAM = glitch in corporate governance. In case there is a change to the Fare Adjustment Mechanism (FAM), we believe this may hurt the corporate governance of MTR and the reputation of the Hong Kong financial market. While we consider privatising MTR the best option, we believe the government can also make use of the dividend it receives from MTR to subsidise the fare increase.

■ Catalysts. While we believe the up/downside risks of MTR are fairly balanced, we believe the increasing discussion of the privatisation option over the next few months is likely impact its share price positively. We estimate the NAV of MTR at HK$32.1 (a 27% premium to the current price).

■ Valuation. Using a scenario approach and assigning 25% probability to a privatisation, 25% to the government using its dividend to mitigate the fare increase and a 50% chance of the change in the FAM, we estimate the expected value of MTR at HK$26.1. We believe most of the downside risks have been discounted. We believe there is near-term upside mostly from the increasing talk of privatisation for the company. Share price performance


Price (LHS)

Rebased Rel (RHS)

27 22 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12

120 110 100 90 80

The price relative chart measures performance against the HANG SENG INDEX which closed at 19233.94 on 15/06/12 On 15/06/12 the spot exchange rate was HK$7.76/US$1

Performance over Absolute (%) Relative (%)

1M -1.2 -2.7

3M -7.3 0.6

12M -6.5 4.9

Financial and valuation metrics Year Revenue (HK$ mn) EBITDA (HK$ mn) EBIT (HK$ mn) Net profit (HK$ mn) EPS (CS adj.) (HK$) Change from previous EPS (%) Consensus EPS (HK$) EPS growth (%) P/E (x) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) Net debt/equity (%)

12/11A 33,423.0 16,411.0 13,205.0 10,468.0 1.81 n.a. n.a. 20.0 14.0 3.0 9.3 1.1 8.5 5.5

12/12E 35,798.5 15,292.4 12,202.8 9,492.0 1.62 0 1.45 -10.1 15.5 2.8 10.2 1.1 7.1 7.7

12/13E 37,475.4 15,819.8 12,601.4 9,878.0 1.68 0 1.58 3.3 15.0 2.3 9.4 1.0 7.0 2.1

12/14E 38,947.3 13,229.2 10,067.8 7,831.2 1.32 0 1.66 -21.2 19.1 2.3 10.9 1.0 5.3 Net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates.

DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.


BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access

19 June 2012

Financial summary Figure 1: Income statement Year to 31 Dec (HK$ mn)






12,459 3,715 3,200 10,144 29,518

13,509 4,420 3,215 12,279 33,423

14,335 4,708 3,863 12,893 35,799

14,987 5,007 3,943 13,538 37,475

15,669 5,107 3,956 14,214 38,947

(18,646) 10,872

(21,946) 11,477

(23,182) 12,617

(24,477) 12,998

(25,718) 13,229

Profit on property development EBITDA

4,034 14,906

4,934 16,411

2,676 15,292

2,821 15,820


Depreciation EBIT

(3,120) 11,786

(3,206) 13,205

(3,090) 12,203

(3,218) 12,601

(3,161) 10,068

Total others Profit before taxation

(1,237) 10,549

(921) 12,284

(996) 11,207

(932) 11,670

(853) 9,214

Others (exceptional/non-recurring items) Taxation Minority interests Underlying earnings

139 (2,031) 8,657

297 (2,044) (69) 10,468

150 (1,865) 9,492

150 (1,942) 9,878

150 (1,533) 7,831






Turnover breakdown Hong Kong fare revenue Station commercial and rail related revenue Rental, management and other revenue Railway franchise revenue outside of Hong Kong Total Operating cost EBITDA before property development

YoY change (%) Source: Company data, Credit Suisse estimates

Figure 2: Estimated NAV breakdown NAV

NAV per share

Basis of valuation

(HK$ mn)


% of total NAV

% of firm value

Book cost, 10% discount Rental capitalisation DCF DCF

2,841 58,809 20,061 12,436 94,147

0.5 10.1 3.4 2.1 16.1

2 31 11 7 50

1 30 10 6 48


80,468.20 10,474.45 2,754.36 1,200.33 5,477.38 1,845.23 1,681.67 103,901.62

13.8 1.8 0.5 0.2 0.9 0.3 0.3 17.8

43 6 1 1 3 1 1 55

41 5 1 1 3 1 1 52

Total assets





Less: net debt







Self-occupied property Investment property MTRC's development property KCRC's development property Total property assets Rail-related assets Overseas rail assets West Island line expansion South Island line Shatin Central line Express railway Kwun Tong line extension Rail-related assets

NAV Source: Company data, Credit Suisse estimates

MTR Corporation (0066.HK / 66 HK)


19 June 2012

Ticket to a private party The SAR government should privatise MTR: the case With social pressure on the government increasing to change the Fare Adjustment Mechanism (FAM) when it comes up for review at the end of this year, we believe the best option for the government is to privatise MTR. The main reasons why we believe a privatisation makes sense are: (1) Increasing political pressure for the government to intervene in the fare autonomy of the MTR. (2) A potential breach of the spirit of the FAM would hurt the image of corporate governance in Hong Kong. (3) There is no real equity fund-raising from MTR or the Hong Kong government. (4) The actual net cash outflow from the government is limited.

The other scenarios Apart from the privatisation/re-nationalisation of MTR, we believe there are two other possible outcomes: (1) Government making use of its annual dividend received from MTR to subsidise the transportation costs of needy people. (2) The FAM review resulting in a change in formula which is acceptable to both MTR and the government. Any change in the formula of the FAM will require agreement from both the MTR and the government. However, minority shareholders will be left out of the decision, although the government and MTR are, in fact, connected parties. Any change in the FAM is considered to be most detrimental to the corporate governance of MTR and the Hong Kong financial market. On the other hand, the government using its dividend to subsidise the fare increase is supposed to be the simplest way to minimise the impact to every party and this should be the best-case scenario for MTR. The drawback is that the fare increase would still have the impact of boosting headline CPI.

Share price seems to have discounted most risks While a privatisation scenario is expected to provide about 27% upside for the share price from the current level, we believe there is a higher chance for downside with a potential change in the FAM of which we have assigned a 50% probability for occurrence. We believe the chance for either a privatisation or the government using its dividend to subsidise the fare increase are each a 25% chance. Figure 3: Expected value of MTR at various scenarios Probability

Expected value


Privatisation of MTR



At its estimated NAV

Government subsidises fare increase Change of FAM Expected value

25% 50%

25.6 23.3 26.1

Our base case forecast without change to any fare increase Assume 0% fare changes going forward

Source: Company data, Credit Suisse estimates

Based on the assigned probability, the expected value of MTR is at about HK$26.1, which indicates that the current share price has factored in most of the risks for this instance.

MTR Corporation (0066.HK / 66 HK)


19 June 2012

FAM was the main merit of the rail merger Mounting social pressure After MTR announced its calculated fare increase of 5.4% in March this year based on the FAM formula, there were strong grass-roots protests and politicians have been pressing the government to “do something” about it. In mid-May, MTR announced its largest package of new fare promotions ever to give back to passengers the full value of the additional revenue it would receive in the year from the 2012 fare adjustment, bringing savings of approximately HK$670 mn to passengers. FAM was approved by the Legislative Council The FAM was part of the package of the merger between MTR and KCRC. Unfortunately, the FAM will be subject to review every five years after its implementation. Its first review is scheduled at the end of 2012. Under the FAM, the overall fare adjustment rate = 0.5 x YoY change in CCPI + 0.5 x YoY change in nominal wage index of the transport services sector – t. Here “t” is a productivity factor and it was deemed to be zero in the first five years following the merger and will have a value of 0.1% starting from the sixth year following the merger for five years. Under the agreement, either the government or the MTR can request a review of the formula on the review date. If there is no agreement of a new formula from the review, it will revert to the original formula. A contract is a contract The merit of the FAM is that it is completely transparent and free from the government’s intervention. Despite the company’s claim of fare autonomy before the FAM was in place, MTR’s fare adjustments always ran behind inflation. From the time MTR was listed in 2000, while inflation has increased by 11%, MTR’s average fare for the domestic line only increased by 2% and its announced fare adjustment was, in fact, down by 1% during the period. Figure 4: MTR’s fare adjustment has significantly lagged CPI 115





90 End 1999






Actual average domestic fare (indexed)

2005 CPI







Announced fare increase (indexed)

Source: Company data,

Profitability does not guarantee social services Compared to other property companies in Hong Kong, MTR’s return on invested capital (ROIC) is in fact very respectable, averaging about 8.7% since its listing in 2000. However,

MTR Corporation (0066.HK / 66 HK)


19 June 2012

MTR’s ROIC will be significantly lower, at 6%, if the property development earnings are excluded from operations. Figure 5: MTR generated an average ROIC of 8.7% since 2000 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 2000


2002 ROIC







ROIC ex property development earnings




Average ROIC

Source: Company data, Credit Suisse estimates

Property development, part of the operations of MTR, is an integral offer to equity investors ever since it came to the market in 2000. It is because of the higher ROIC spread (less of cost of capital) that MTR generates, that investors have been rewarding the company with above-the-book valuation. Equity investors paid the full price but not for social services This is not a free-lunch for equity investors as they have paid the full premium for what the company earned. On the other hand, profitability on the company side does not automatically guarantee a free social service which should be the responsibility of the government and was not written in the prospectus or merger document of MTR when investors decided to invest in the stock. Figure 6: MTR has mostly been EVA positive since listing 1.50



7.0% 6.0%




4.0% 1.10 3.0% 1.00







-1.0% 2001













Source: Company data, Credit Suisse estimates

MTR Corporation (0066.HK / 66 HK)


19 June 2012

Giving government’s dividend as social support to cushion fare changes While it is not the responsibility of MTR to provide social service, the government is free to use its dividend from MTR to provide financial support to the needy in society. We estimate that the government receives about HK$1.8 bn of cash dividend from MTR p.a. A 5% increase in MTR’s fare is about HK$680 mn. Theoretically, the government’s annual dividend can cushion about 15% of a change in MTR’s fare. Of course, there will be administrative costs if the government distributes the subsidies to the public. However, those costs should be substantially lower than hurting the image of corporate governance in Hong Kong.

Breach of the FAM = glitch in corporate governance Minority shareholders are vulnerable in this case There are still several months before the actual review of the FAM starts. While the dollar amount in question is relatively small—i.e. a 5% change in fare = HK$680 mn—the issue is on the potential damage to corporate governance in Hong Kong. The Hong Kong government is the largest shareholder of MTR and it is going to negotiate with MTR at the end of this year on potential changes to the FAM. On paper, although the rules of connected party transactions does not apply in this case, we think this is a connected party transaction in substance and the outcome of the negotiation should be thrown to a vote in an EGM especially if the potential changes are going to be negative to the future valuation of MTR. The fact that minority shareholders do not have the right to participate in such a decision-making process is detrimental to corporate governance, to MTR as well as the Hong Kong financial market.

Why keeping MTR listed? MTR was listed in October 2000 when the government sold 23% of the company, raising HK$10.2 bn. This was the first of the privatisation moves by the government followed by the privatisation of The Link in November 2005 (which raised HK$22 bn for the government). There has been talk about the privatisation of the Airport Authority as well. However, given increased pressure on the government to control the pricing of quasi-government corporations such as MTR and Airport Authority, we believe that investors would find the’ appeal of such offerings to be limited. On the one hand, MTR does not require to list as it does not require additional funding from the equity market. Under the three financing models of the rail expansion—(1) rail + property; (2) government’s subsidies; and (3) concession—MTR does not require significant funding from the equity market. On the other hand, the government does not need to raise cash by further selling down the shares. The need to ensure corporate efficiency for a quasi-government corporation through privatisation is now being overshadowed by the need for the government to provide more social services. Rather than hurting the minority shareholders of MTR and putting the government in a difficult position, we believe the easy way out for the government would be to privatise MTR, or re-nationalise it.

Not a large amount of money to the government Over the last 11 years, MTR has paid out HK$29.5 bn in dividends, mostly cash and partly shares. Since the Hong Kong Government holds a 77% stake in MTR, it has received dividends totalling HK$22.6 bn from the company.

MTR Corporation (0066.HK / 66 HK)


19 June 2012

Figure 7: Dividend payment by MTR since listing MTR's dividend (HK$ mn) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Total

Stake Government

500 2,116 2,153 2,187 2,242 2,281 2,314 2,509 2,705 2,962 3,096 4,388 29,451

77% 77% 77% 77% 77% 77% 77% 77% 77% 77% 77% 77%

Minority 23% 23% 23% 23% 23% 23% 23% 23% 23% 23% 23% 23%

Dividend rec'd (HK$ mn) Government Minority 385 1,628 1,656 1,681 1,723 1,752 1,777 1,925 2,075 2,271 2,373 3,361 22,608

115 487 497 505 519 529 537 583 630 691 723 1,027 6,844

Source: Company data, Credit Suisse estimates

Together with the HK$10.2 bn that the government raised during the IPO, it has received a total of HK$32.8 bn from MTR and the minority shareholders. Assuming that MTR were privatised at its estimated NAV of HK$32.1, or a 27% premium to the current share price, we estimate a total consideration of HK$44.4 bn would need to be paid by the government. Figure 8: Potential net cash flow of the government under a privatisation scenario HK$ mn Initial money raise in IPO Dividend received Total

10,212 22,608 32,820

Current price of MTR Minority shares (mn) Privatisation premium Potential privatisation price (HK$) Privatisation amount (HK$ mn)

25.25 1,384 27% 32.1 44,380

Net amount used in potential privatisation


Source: Company data, Credit Suisse estimates

Netting off the IPO money and the dividend received by the government, the final amount to be paid the government would only be HK$11.6 bn. We believe this will not pose a big burden to the government as this will only represent three years’ worth of dividends from MTR.

MTR Corporation (0066.HK / 66 HK)


19 June 2012

Companies Mentioned (Price as of 18 Jun 12) MTR Corporation (0066.HK, HK$25.55, NEUTRAL, TP HK$25.64)

Disclosure Appendix Important Global Disclosures Cusson Leung, CFA & Joyce Kwock each certify, with respect to the companies or securities that he or she analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. See the Companies Mentioned section for full company names. 3-Year Price, Target Price and Rating Change History Chart for 0066.HK 0066.HK Date 6-Aug-09 12-Aug-09 1-Mar-10 10-Mar-10 9-Aug-10 9-Nov-10 4-Mar-11 8-Jun-11 22-Jul-11 11-Aug-11 29-Feb-12 9-Mar-12 19-Apr-12

Closing Price (HK$) 27.7 28 27.25 28.8 29.05 30.7 29.05 27.55 26.9 24.6 27.6 27.85 27.35

Target Price Initiation/ (HK$) Rating Assumption 28.643 N 27.908 27.911 28.7 33.1 O X 35.8 36.243 X 37 36.8 32.491 32.277 32.488 25.637 N

38 36



37 37

34 33



32 32

30 28

29 28


29 28





24 9-Aug-10


Closing Price

Target Price




O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered

The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities. Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months.

MTR Corporation (0066.HK / 66 HK)


19 June 2012

Credit Suisse’s distribution of stock ratings (and banking clients) is: Global Ratings Distribution Outperform/Buy* 48% (59% banking clients) Neutral/Hold* 41% (56% banking clients) Underperform/Sell* 9% (52% banking clients) Restricted 2% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

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19 June 2012

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MTR Corporation (0066.HK / 66 HK)


19 June 2012 Asia Pacific/Hong Kong Equity Research

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