Introduction We focus on SMRT Corporation Ltd (SMRT) and SBS Transit Ltd (SBS). The market for their common equity (E), debt (D) and preferred stock (PS) are summarized here: | |E (SGD$) |D (SGD$) |PS (SGD$) |D/(D+E+PS) |E/(D+E+PS) |PS/(D+E+PS) | |SMRT |309.8M |472.3M |0 |60.39% |39.61% |0 | |SBS |649.7 M |212.2M |0 |24.62% |75.38% |0 |
Debt was derived by adding short term borrowings to total long term liabilities as reported in the balance sheets (Exhibits 1 and 2). In addition, we added $100M to SBS’s long term debt as their latest financial statements were released before their 5 year notes were issued in Oct 10. Both companies have not issued preferred stock. Cost of Equity We use the yield on 20 year Singapore Government bonds, 3.36%, as the long term risk-free rate. To obtain the market premium, we refer to a report that polled individuals on what they used as risk premiums. In particular, the Singapore market had responses from 5 analysts. As these individuals are considered industry experts, we deem it reasonable to use the average of their responses, 6.3%, as the appropriate risk premium. Beta is estimated by taking the slope of the companies’ stock against market returns regressions. The estimated period is 5 years at monthly intervals. The data is found in Exhibit 3, while the Beta results for SMRT and SBS are 0.31 and 0.48 respectively. Their cost of equity is now calculated in accordance to CAPM: Cost of Equity (Ke,SBS) = Rf + βSBS * (E(Rm) – Rf) = 3.36% + 0.48 * 6.3% = 6.38% Cost of Equity (Ke,SMRT) = Rf + βSMRT * (E(Rm) – Rf) = 3.36% + 0.31 * 6.3% = 5.31% SBS has a higher cost of equity resulting directly from a higher Beta (though both stocks do not have high Betas). A possible reason for this is the fact that SMRT’s business is more diversified and investors feel that it is a more stable company compared to SBS. Cost of Debt SMRT currently has 2 outstanding bonds: SGD$100M, 5 year, 3.27% fixed-rate notes due Dec 11 and SGD$150M, 5 year, 2.42% fixed-rate notes due Oct 14. The prevailing risk free rates when these were issued were 3.03% and 1.33% respectively (see Exhibit 4). Therefore, they had a 0.24% and 1.09% premium at their respective issuance dates. From a S&P report, we note that the credit spreads between mid 2003 to mid 2007 were relatively stable, climbed to a peak towards end 2008, before subsiding to a gradual decline in the recent years (see Exhibit 5). We surmise that SMRT’s bond premium would therefore ease from 1.09% towards 0.24% over the years. We deem it reasonable to take an average of the two rates, 0.67%, as indicative of the long term credit spread over the risk free rate for mid term bonds. To adjust for long term bonds, we interpolate the increase in credit spreads between 5 and 30 year AAA corporate bonds (SMRT was rated as AAA by S&P) taken from Reuters, which results in an additional 48 basis points for a 20 year bond (40 basis points from 5 to 10 year bonds, and another 8 basis points in between 10 and 30 year bonds). We therefore estimate SMRT’s long term cost of debt as: 20 year risk free rate + 20 year corporate spread = 3.36 + (0.67 + 0.48) = 4.51% SBS issued SGD$100M, 5 year, 1.95% fixed-rate notes in Oct 10 at a 1.06% premium over the prevailing risk free rate (Exhibit 4). We deem it reasonable to surmise that SBS’s bond spread is similar to SMRT’s and the 3 basis point difference between their latest 5 year notes is attributable to the recent gradual decline in spreads. Further, we note that SMRT’s AAA rating is based on the assessment that SMRT enjoys a “very high likelihood of extraordinary government support”. It is reasonable to assume that SBS would also...
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