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No one can dispute MTR Corporation Limited’s (SEHK:66) profitability and how the subway is so operationally efficient. Although MTR fares are relatively cheap, they nevertheless cover around 170% of the subway system’s operational costs.
Recently, its shares have been punished by investors – driven by a public backlash over the anti-government protests. However, if we look at the company from a purely fundamentals perspective, it remains an extraordinary business.
Just take a look at its earnings for 2018. MTR reported an underlying business profit of HK$11.3 billion on sales of HK$53.9 billion and 99.9% of the company’s around 2 billion passenger journeys were on-time.
Rail + property model
Although its operational efficiency helps, MTR’s profitability is also due to its “rail plus property” business model. As MTR CEO Jacob Kam put it:
“Once we build the railway, the value of the land rises and we capture the increase in value.”
MTR captures the value by developing property such as malls or hotels next to subway stops, which gets a lot of foot traffic. Due to this, the property developed around subways is worth a lot more than what MTR originally paid. As great as its model is, shareholders also have another reason to like the stock.
MTR’s consultancy business is hidden gem
Because MTR is so operationally efficient and it’s the only major subway system in the world that’s profitable without subsidies, there is a lot of demand for MTR’s consulting services.
Every subway wants to be more like MTR and many are willing to pay to learn its efficient building and operational methods. Although not every city is willing to offer their subway operators Hong Kong’s generous property concessions, CEO Kam believes many are thinking about a similar approach given its remarkable success.
By consulting other subway systems, MTR realises a healthy margin business without taking on much risk. Investing substantial capital and numerous years into large-scale projects before getting a return isn’t a great business model.
On the other hand, advising other subways on how to make their systems more efficient and letting them take on the capital and operational risk themselves is a great business model.
Source: MTR Corporation Annual Report 2018
MTR’s consultancy business, although not huge, is also not a negligible part of its business. More importantly, it’s growing. In 2018, it made up almost 10% of sales and the operation actually grew 23% year-on-year despite MTR’s total sales shrinking almost 9% year-on-year.
Although most of MTR’s consultancy business growth for that year was due to more work performed for the Automatic People Mover System for Hong Kong’s International Airport, MTR’s consultancy business has a lot of potential given the planned infrastructure boom around the world – with subway systems a key part of that.
There is a lot to like about MTR stock. It’s not only operationally profitable, but it also has a promising business with real estate and consulting. Many investors regard it as a “defensive stock” given it is an essential part of everyday life in Hong Kong.
It’s a company that will be profitable in good times and bad, if it continues to be well run.
The stock isn’t without its faults, however. MTR’s weakness is that it isn’t geographically diversified. Some also think that the stock is still too expensive given its forward price-to-earnings (PE) ratio of around 25.
In the long run, though, I believe MTR’s operations will return to normal and the company will prove to be a sound long-term investment.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Jay Yao doesn’t own shares in any companies mentioned.