Singapore’s largest rail operator SMRT (SGX: S53) announced last Friday evening that rating agency Standard and Poors had revised its outlook for the company to “negative”.
While the news isn’t exactly positive, it’s also probably not as bad as it looks.
For those unclear about what a “negative”” outlook means, it might appear really scary. Butaccording to S&P, a “negative” outlook simply means that it “anticipates that a credit rating may change in the coming 6 to 24 months.”
And, the direction of the possible change is given in its outlook, which in the case of SMRT, would mean that S&P anticipates a possible downward revision to the rail operator’s credit rating.
As for how it affects investors, generally speaking, lower credit ratings for a company would mean that its costs for borrowing would likely increase, thus reducing the profits that would accrue to shareholders, assuming everything else remains the same.
SMRT’s credit rating, even after S&P’s “negative” outlook, remains at AAA. That’s thehighest credit rating under the rating agency’s rating-system, suggesting that strong confidence in the rail operator’s financials still remains. S&P describes a company with a credit rating of AAA as having “extremely strong capacity to meet financial commitments.”
That said, the “negative” outlook also means that the rating agency’s seeing things in the rail operator’s financials that could worsen. But before we dig in further, I’ll like to point out that it’s not just the rating agency that’s concerned with the company.
The stock market also seems to have its fair share of worries with SMRT’s corporate performance, judging by the 22% decline in the rail operator’s share price over the last 12 months even as the general market, represented by the Straits Times Index (SGX: ^STI), has managed to gain 5% or so.
Coming back to S&P’s concerns, it had issued a “negative” outlook on SMRT’s credit rating because the company’s “financial performance has been weaker than…expected.”
While I’m not privy to the rating agency’s expectations for SMRT’s numbers, the rail operator’s latest first quarter results weren’t exactly its best with a 55% year-on-year drop in quarterly net profit to S$16.3m despite a 3.5% rise in revenue for the quarter to S$285m.
SMRT’s profit margins had declined on the back of rising operating costs, which was one of the areas of concern going-forward that was factored in by S&P in its analysis of the company’s financial risk profile that partially contributed to the “negative” outlook.
The rating agency also highlighted the importance of financial support from Singapore’s government which might improve SMRT’s capital-spending burdens. S&P “anticipate[s] SMRT’s capital spending to remain high at about Singapore dollar (S$) 600m” for fiscal year (FY) 2014.
But, it also noted that the rail operator’s financial burdens might be eased in FY 2015 “with the implementation of a new rail financing framework for [its] operating infrastructure” ifthere’s a “positive and timely outcome” from SMRT’s discussions with the government.
While S&P is of the view that SMRT would very likely receive “extraordinary government support”, investors should still keep an open eye out for any worsening of the rail operator’s financials.
Foolish Bottom Line
SMRT’s business risk profile is still rated as “excellent” by S&P, given the company’s dominance of the rail sector here with a 78% market share and steady growth in railpassenger numbers over the past two years from 604m in FY 2011 to 691m FY 2013 “despite breakdowns in Dec 2011.”
But, if SMRT’s credit ratings slip during a period when it has to refinance its loans, its profit margins might get squeezed yet further, adding oil to fire – the rising operating costs – which would not be a good thing for shareholders.
That’s something for investors to keep in mind.
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