The only certainty this Spring Carnival is that the tote will win. Last year, according to Racing Victoria, betting turnover reached a record $2.35 billion over the entire Spring Carnival, up 5.4%. Melbourne Cup Day saw an Australian record for turnover on an individual meeting with $334.5 million bet domestically; domestic turnover on the Melbourne Cup itself topped $200 million for only the third time with $204.5 million invested.
The annual Spring Carnival betting surge is testament to Australians’ love of the punt, but these days, there is growing concern over the social impact of gambling. It is just one of the industries in which the concept of “social licence to operate” is being closely scrutinised, in everything from lotteries to wagering, to casinos.
Gambling companies address this in two ways. The first is to emphasise the tax and industry support, and philanthropic fundraising that gambling companies throw off; and increasingly, the support for research into and redress of gambling addiction.
The second is to stress the role of “entertainment” in their business model. That is much more palatable than focusing on the fact that for a small minority of people, gambling can be an addiction that ruins lives and families. More than ever before, investors now assess the gambling stocks with at least the knowledge that there are serious ethical concerns over deriving return from other people losing money.
However, the fact that these are perfectly legal businesses and that gambling is a person’s choice – combined with the fact that the gambling businesses do not lose in the long run, makes the investment a certainty, other corporate action notwithstanding.
Here’s a rundown of the form guide for the gambling stocks.
1. Tabcorp Holdings (TAH, $4.51)
Market capitalisation: $9.1 billion
Forecast yield FY19: 4.9%, fully franked
Analysts’ consensus target price: $5.20
One-year total return: 8.2%
Three-year total return: 2.1% a year
Five-year total return: 11.7% a year
The December 2017 merger between Australian gambling giants Tabcorp Holdings and Tatts Group created a company with three main business divisions – Lotteries & Keno, Wagering & Media, and Gaming Services. Almost half (48%) of the merged company’s revenue comes from Wagering and Media (Sky Racing), 46% comes from Lotteries/Keno, and 6% from gaming services.
The merger saw Tabcorp’s revenue for FY18 climb 72% to $3.8 billion, earnings before interest, tax, depreciation and amortisation (EBITDA) rise by 46% to $736.4 million, and net profit lifted by 38% to $246.2 million.
Tabcorp is a guaranteed winner on every wager: in fact, it keeps about 17 cents of every dollar wagered. About one-third of this is paid to the relevant state government, about one-third to the racing industry, and the company keeps the rest. After covering costs and taxes, more than 2 cents of every dollar bet is clear profit to Tabcorp.
Despite clipping the ticket on every bet, Tabcorp is not always a profitable operation: like every company, it has company-specific issues from time to time. For example, from a $170 million profit in FY16, Tabcorp slumped to a $20.8 million bottom-line loss in FY17, hammered by a series of hefty bills from legal actions – including $62 million from an Australian Transaction Reports and Analysis Centre (AUSTRAC) prosecution for breaches of the anti-money-laundering and terrorism funding act – as well as write-downs from a UK joint venture it exited and costs associated with the Tatts takeover.
The company continues to bed down the Tatts business, and work to extract the synergies, which means that investors looking at the stock now have a clearer picture – and a more attractive buying proposition – than has been visible for a couple of years. They can now benefit from the strong yield – the 4.9% fully franked yield projected for FY19 equates to a grossed-up yield of 6.9%, and on Thomson Reuters’ collation of analysts’ expectations, FY20 is expected to deliver 5.4% nominal yield (grossed-up, 7.7%). On top of that, analysts see healthy scope for the share price to rise, indicating a buoyant outlook for total return.
2. Crown Resorts (CWN, $12.35)
Market capitalisation: $8.5 billion
Forecast yield FY19: 4.9%, 60% franked
Analysts’ consensus target price: $13.65
One-year total return: 14.4%
Three-year total return: 9.2% a year
Five-year total return: –0.6% a year
Like Tabcorp, Crown Resorts wins on every bet placed at its casinos – I beg your pardon, “resorts,” of which it has two, in Melbourne and Perth, with Crown Sydney, at Barangaroo on Darling Harbour, on schedule to be opened in 2021. But that lucrative fact has not stopped the company losing money, and being a dud investment as a stock for long periods of time, on the back of company-specific issues.
Crown Resorts is the business into which James Packer switched the Packer family’s business focus, away from media, after the death of his father, Kerry. James Packer holds the controlling interest in Crown Resorts, with a 46% holding worth $4.2 billion at the current price, while his sister Gretel owns a stake worth $1.1 billion.
Long-term investors in Crown watched in dismay as the company embarked on, and later retreated from, an ambitious overseas expansion that was mostly fuelled by debt. James Packer wanted Crown to become a global casino and entertainment brand, with operations in Macau, and expansion planned in London, Las Vegas, the Philippines and Japan. But the arrest of ten Crown employees in China in October 2016 triggered a retreat, under which Crown eventually sold out of its Macau-based joint venture Melco Crown and offloaded its final stake in Melco Resorts & Entertainment. The retreat from Macau cost Crown investors $2.5 billion.
The company has pulled back completely to Australia, and the debt on the Crown balance sheet has been pruned back drastically over the last four years. The performance of the stock has suffered, but like Tabcorp, Crown Resorts now looks a far more interesting investment proposition than it has for some time. By 2021, Crown will have three excellent cash-generating assets, and should be virtually clear of debt.
Again, investors have to be clear on their attitude to the ethics of profiting from investing in casino gambling.
3. The Star Entertainment Group (SGR, $4.59)
Market capitalisation: $4.2 billion
Forecast yield FY19: 4.8%, fully franked
Analysts’ consensus target price: $6.13
One-year total return: –13.1%
Three-year total return: –0.09% a year
Five-year total return: 14.9% a year
Star Entertainment is the arch-rival of Crown Resorts: it operates the original Sydney casino, The Star – also on Darling Harbour – as well as the Jupiters hotels and casinos on Queensland’s Gold Coast, and The Treasury hotel and casino in Brisbane. It also manages the Gold Coast convention and exhibition centre. Star Entertainment Group will open its $500 million Ritz-Carlton hotel in Sydney in 2022.
Star Entertainment also heavily emphasises the tourism and entertainment part of its business – and it is true that, as with Crown, plenty of people will stay at, and eat at, its resorts without gambling – but the fact is that gambling is the main source of revenue.
In FY18, revenue was up 5.5% to $2.47 billion, while normalised net profit (based on the average win rate) surged 20%, to $258.1 million. The result was actually a bit soft in the Queensland operations, where gross revenue rose 10.5% to $820 million, but EBITDA slipped back by 8.4%, to $178 million. The highlight of the result was a 56.7% increase in VIP turnover at The Star in Sydney: casinos need to have their biggest players at the tables, and playing – hence the rebates and travel assistance they offer their VIPs.
Investors can profit from these VIPs – and all other players – playing, and losing. On a total-return basis, with a healthy yield and analysts tipping a price rise, buying Star Entertainment shares at the current price looks a lot more certain an investment proposition than playing at its tables and machines.
4. SkyCity Entertainment Group (SKC, $3.40)
Market capitalisation: $2.3 billion
Forecast yield FY19: 5.4%, fully franked (for New Zealand shareholders)
Analysts’ consensus target price: $4.04
One-year total return: 3.3%
Three-year total return: 1.9% a year
Five-year total return: 5.2% a year
SkyCity Entertainment Group operates casinos in Auckland, Hamilton and Queenstown (two casinos) in New Zealand, and Adelaide and Darwin in Australia. The Auckland and Darwin casinos are integrated developments with hotels. SkyCity currently has two major growth projects underway, the development of the new New Zealand International Convention Centre in Auckland, and a major redevelopment of the Adelaide Casino
In FY18, SkyCity’s revenue lifted by 7.3% to almost NZ$1.1 billion, while reported net profit rose 277.9% to NZ$169.5 million. However, this was because the FY17 result included a NZ$95 million impairment of goodwill for its Darwin casino: normalised net profit was up 10.4%, to NZ$169.9 million. The revenue split was close to 60% New Zealand, 40% Australia: the actual win rate on international business (IB) was 1.32% for FY18, up from 1.27% in FY17. Strong growth in IB, particularly in Auckland, was a major driver of the result, generating record earnings from the Auckland casino.
On Thomson Reuters’ collation, analysts have a target price 19% higher than the current share price, and a 5.4% yield. The problem for Australian investors is that the imputation credits from fully franked New Zealand dividends are not available to Australian residents: the New Zealand government refunds the imputation amount to foreigners, minus 15% withholding tax. This refund is paid as a supplementary dividend, which makes New Zealand dividends not as tax-effective for Australian investors as local stocks paying fully franked dividends: this is a very important consideration for SMSFs.
5. Jumbo Interactive (JIN, $7.64)
Market capitalisation: $456 million
Forecast yield FY19: 3%, fully franked
Analysts’ consensus target price: $6.31
One-year total return: 151.9%
Three-year total return: 96.6% a year
Five-year total return: 27.7% a year
Online lottery seller Jumbo Interactive has emerged in recent years as a major player in Australian lotteries, operating the website www.ozlotteries.com, where retail customers can buy lottery tickets in the major draws operated by Tabcorp, including Oz Lotto and Powerball. Tabcorp has what it calls a “strategically important holding” in Jumbo Interactive, currently a 12.49% in the company.
Jumbo Interactive reported a healthy result for FY18, with revenue up 23%, to $39.8 million, total transaction volume (TTV) rising by 26%, to $183.1 million, and net profit (from continuing operations) up 55%, to $11.8 million. The fully franked dividend more than doubled, from 8.5 cents a share to 18.5 cents, and shareholders also received two special dividends in FY18 – a fully franked payment of 15 cents in August 2017 and 8 cents a share in July (for shareholders on the register at June 15, 2018).
The deal with Tabcorp is interestingly symbiotic, because Jumbo Interactive’s site competes with Tabcorp’s own retail site, thelott.com, but acts as a channel to sell more tickets. Tabcorp is the sole supplier of lotteries to Jumbo, with the supply agreement having just under four years to run. That supply agreement is the biggest risk for Jumbo Interactive: if Tabcorp were to not renew the deal – or renew it on less favourable terms to Jumbo Interactive – the latter’s profitability could be significantly impacted. The profit opportunity for Jumbo Interactive is to increase the online sales of lottery tickets: it says that currently, only 18% of Australian lotto tickets are sold on the internet, compared to the UK penetration, at 22%, and Finland, where it is at 48%. Jumbo believes it can grow Australian internet penetration to 22% by 2020.
Jumbo Interactive has recently opened up another line of business, positioning itself as the online distribution partner to some of Australia’s largest charity lotteries. About $1 billion of charity lottery tickets are sold in Australia each year, but because the charities use basic marketing techniques to sell tickets, they don’t achieve the sales and margins they could: Jumbo Interactive offers the ability to do this. Jumbo’s sales of charity lotteries grew by 60% in FY18, to $6.1 million: it has a lot of potential to grow its business in this market.
Boosting the sales of Tabcorp lottery tickets online and through mobile – which now accounts for 75% of Jumbo’s customer interactions – is the main game for Jumbo. At this stage, it’s a relationship that benefits both parties. The only problem for potential investors is that Jumbo has run very strongly: its shares sold for $1 at the start of 2016, but almost reached $8 earlier this month. Analysts think it is priced far too fully at present.
Aristocrat Leisure (ALL, $26.01)
Market capitalisation: $16.6 billion
Forecast yield FY19: 2.2%, fully franked
Analysts’ consensus target price: $34.00
One-year total return: 13.3%
Three-year total return: 43.9% a year
Five-year total return: 42.4% a year
Another way to “play” the gambling market is to invest in the companies that make the poker machines: Australia has two major world participants in this market, both founded by the same person, Len Ainsworth.
Ainsworth’s original business, Aristocrat Leisure, is one of the world’s biggest makers of electronic gaming machines (EGMs) and casino management systems. Aristocrat Leisure’s core pokie machine business has consolidated its dominance in recent years, and its digital business has started to kick big goals as well. Along the way, Aristocrat has become one of the ASX’s true global leaders, and also one of its best exposures to a falling Australian dollar – about two-thirds of Aristocrat’s earnings are derived in the USA. This attribute is a significant benefit in the present environment.
Look at those numbers for three- and five-year total return: Aristocrat has been a great stock to own. And its outlook remains very robust, with analysts seeing 30%-plus growth potential in the share price.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.