Gambling is not everyone’s cup of tea, but there is money to be made as a gambling sector investor.
We think there is an opportunity to switch out of Tatts Group into Crown based on relative valuations.
Roughly segregating the casino operators Crown and Echo Entertainment from the wagering, gaming and lottery operators Tatts Group and Tabcorp gives a starting point to look at the sector.
Crown versus Echo
Crown and Echo are locking horns over the Sydney scene but apart from that little overlap, Crown is demonstrably a superior company.
Echo’s travails have largely been self-inflicted which is disappointing as the stock could have been a solid performer following its split away from Tabcorp. Indeed, the rationale for the split was to allow the market to value Echo more appropriately against other casino groups thus enhancing its value. The wagering and gaming core of Tabcorp’s business had been seen as a drag on the valuation of the casino businesses.
The split was good in theory but alarmingly bad in practice.
Echo is now fighting fires on several fronts. The biggest is the defence of its core asset, The Star casino in Sydney where the Crown proposal across the water is threatening to carve a big hole in The Star’s high roller revenues and earnings if and when it gets up and going in a few years.
Perhaps with the exception of the Gold Coast casino, Echo’s other Queensland casinos are arguably too small to make a material difference to its bottom line.
Echo now also has both Genting and Crown menacingly poised on its share register giving Chairman John O’Neill plenty to worry about.
Crown’s two Australian casinos in Melbourne and Perth have, by comparison, continued to perform admirably even considering the extended crunch in consumer discretionary spending and the lull in household disposable income – both important factors in gaming expenditure.
Crown continued to plough several billions of dollars into refurbishing and enhancing the two properties and has taken this a step further with a new six-star hotel planned in Perth and of course, the six-star showstopper at the Barangaroo development in Sydney.
The real attraction about Crown as an investment is that the share price is really only reflecting the value of the Australian assets and almost nothing for the now significant Macau investments.
Crown owns 33.4% of Melco Crown Entertainment which is listed in Hong Kong and on the Nasdaq exchange.
Melco Crown Entertainment has just reported its full year result for 2012 which shows it earned just over US$4 billion in revenue, US$995 million in operating earnings and net income of US$417.2 million.
Rolling chip volume at the group’s large City of Dreams property nudged through US$81 billion last year with the upmarket Altira Macau adding a further US$44 billion. The roughly 15% market share of the Macau gaming market is producing very strong growth in non-gaming revenue as well with occupancy at both major properties in excess of 93% for the year.
Melco Crown Entertainment has a third gaming property, Studio City that is scheduled to open in 2015.
Outside of Macau, Melco Crown Entertainment is now making initial steps to invest in the Philippines market alongside key local partners.
It’s not too hard to reconcile a valuation for Crown in excess of $13.60 per share when pieced together. The company’s balance sheet is also very robust.
Echo Entertainment, on the other hand, appears laden with questions and risks that will take time to sort out. Anecdotally, we also don’t like it when unscheduled management and board changes dot the landscape. It signals an unsettled internal culture and environment.
On a more planned and very well scheduled program, Tatts Group chief executive Dick McIlwain has worked through his handover to Robbie Cook who now takes the reigns.
Tatts has steadily accumulated the important lottery licences across the larger states in Australia culminating in its latest win with the South Australian lottery. With the NSW, Queensland and Victorian lotteries on board, Tatts has successfully transformed its business from Victorian gaming machines to Australian lotteries along with a significant wagering business.
The loss of the Victorian gaming machine licence in April 2008 was the nadir of the company’s existence since listing in 2005, but the successful merger with Queensland wagering group UNiTAB and the subsequent acquisitions of the various state lotteries has reignited the interest in the stock.
Court action in Victoria to retrieve $490 million from the state government relating to the loss of the gaming machine licence from August 2012 is underway. It is unrealistic to place any value in the share price for a successful outcome but it remains a possibility.
The transition was so well handled it could serve as a great case study for future finance students.
At the current price, the Tatts story is leaving little room for upside other than a surprise surge in earnings.
Although both stocks have strongly outperformed the ASX200 over the last year, we think it’s worth considering a switch from TTS to CWN for the undervaluation implicit in CWN’s price.