MTR Corp:FAM review concluded,More pressure to give concessions;Sell

After market close on Mar 21, MTRC announced the results of its early FareAdjustment Mechanism (FAM) review for 2017-2022. Two adjustments: (1)FAM formula is largely unchanged still set as “0.5 x CPI + 0.5 x wage index– t”; though “t” is now fixed at zero (vs. prior 0.5 x productivity factorcalculated by dividing its HK transport revenue by expenses, translating to0.6% in recent years), but making it up are special applications whichreduce the fare by 0.6% during the term, with an additional 10% discounton overall fare in FY17 (nil for 2018-2022); (2) modest upward revisions tofare concessions as detailed in Exhibit 1-3.

Implications.

MTRC estimates the above change could reduce its HK fare revenue byHK$368mn or 2% per annum from 2H17 including: (1) HK$226mn foradditional fare concessions (i.e., HK$445mn under the new arrangementvs. prior HK$219mn); (2) HK$142mn loss in FY17 for 10% discount agreedon total fare. Given the group’s fixed cost structure, we expect much of therevenue loss to flow through to its EBITDA translating to a 2-3% impact.

Although the FAM announcement may remove some near-term stockoverhang, it reaffirms our concern that MTRC is likely to face increasedpressure to give more fare concessions at a time when lower inflationalready points to fewer potential fare hikes. Together with more capex foran expanded network, rail operation return appears set to decline.

Valuation.

Factoring in FAM results, we cut our 2017E-19E group EBITDA by 2-3% andour EPS by 1-3%. Our 12m SOTP-based TP falls to HK$34.0 (from HK$35.0),still based on 10% discount on revised FY17E NAV of HK$37.4. While webelieve rich valuation (16% NAV premium, 28x 2017E P/E and 1.9x P/Bagainst its 6.6% ROE) is supported by HK$2.2 special DPS to be distributedin July-17, we think share price will correct to better reflect the group’sdeteriorating fundamentals. Maintain Sell.

Key risks.

More resilient HK macro, better-than-expected property profit shares.