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Morningstar | Rail Over Troubled Water; MTR Overvalued as Investors Refocus on Defensive Yield Stocks

The first half of 2019 for MTR Corporation was relatively tranquil after a tumultuous 2018, with the company focused on executing on its rail and property operation. The same calm cannot be said about the company’s core operational geography of Hong Kong. We expect mixed impact on patronage from the recent protests. The high level of participation in the rallies may have resulted in increased patronage on some lines, and at the same time, may have deterred the wider population from moving about. Year-to-May patronage for domestic services was up 1.7% while the key highlight for the rail operation was a 7.2% increase in commuters on the Airport Express. The latter was driven by stronger tourist arrivals, particularly non-Chinese visitors less reliant on the high-speed rail and cross border services. On the real estate side, LOHAS Park Package Eleven was awarded to a consortium of Sino Land, K.Wah International and China Merchants Land. The Sydney North West Rail Link also successfully commenced operation in the second quarter this year. We leave our estimates unchanged ahead of the first-half result and our fair value of HKD 48 is reaffirmed. With the market expecting U.S. interest rates to remain steady or decline, investors renewed their focus on defensive, yield names such as MTR. A strong rally in its share price has seen our recommendation lowered to 2-stars and we believe the narrow-moat-rated rail operator is overvalued.

The high-speed rail service, launched in August last year, continues to ramp up as daily average trips on the service is around 55,000 passengers per day. This is below the original and revised patronage forecast under the construction of the high-speed rail project. We reiterate MTR is under an operational agreement with the government and the ownership of the line rests with the latter. MTR is subject to penalties if actual patronage is 15% below the estimate under the concession agreement. In an update to the Legislative Council, the company revealed a more conservative estimate was adopted in the service concession agreement and patronage level has not dipped below the lower limit. Interestingly, the usage by Hong Kong residents is estimated to be 30% and the balance non-Hong Kong passengers. This is the complete opposite to the estimate in the original plan. The addition of Mainland destinations will lead to rising patronage in the medium term, in our view.