Echo: Interim result 2015

After becoming Chinese Communist Party chief in November 2012 and Chinese President a few months later, Xi Jinping launched a sweeping crackdown on corruption that has scared wealthy Chinese so much that they have begun to conceal signs of their wealth. Amongst other things, this has meant taking fewer trips to Macau – the world's largest gambling Mecca – resulting in the former Portuguese colony's gambling revenue falling in recent months after many years of rapid growth.

As rich Chinese are some of the most highly sort-after customers of Echo Entertainment and Crown, the crackdown might have also affected these companies' revenues, particularly if you include the second order impact of slowing Australian economic growth on local customers.

Yet neither the Australian economy's continued struggles nor the ongoing crackdown on corruption by the Chinese government have had much effect on Echo's interim result (see Table 1).

Echo continues to reap the rewards of spending nearly $900m upgrading Sydney's The Star, with the casino and its attached restaurants, bars and clubs generating 70% of the company's total revenue in the six months to December. Australian punters have flocked to The Star, helped by economic growth in New South Wales and the company's improved Absolute Rewards loyalty program.

While the enticements dished out under the program caused non-gaming revenue to decline slightly, this represents only 9% of The Star's revenue. This was more than offset by significant increases in poker machine and table game revenue, demonstrating the power of incentives to get punters through the door.

VIP A-ok

A major reason for the refurbishment of The Star was to lure rich gamblers or VIPs and it has certainly achieved this, with revenue from VIPs increasing 87%. This was also helped by the company sourcing more business from Asian junket operators who are paid higher commissions for directing their clients to Australia rather than to competing casinos in Macau, Singapore or the Philippines.

Echo said it had seen little impact from the Chinese crackdown, as many of its VIP customers have additional reasons to visit Australia, such as a business or family. Yet the company faces increasing competition for these customers, not just from competitors such as Marina Bay Sands in Singapore which pays lower taxes on VIP revenue, but also from future competition within Australia itself.

James Packer recently revealed that Crown's VIP-only Sydney casino will comprise 350 rooms and 80 apartments, costing $2bn in total or $4.5m per room. Crown will retrieve some of the construction cost by selling the apartments but this figure shows the lengths it's prepared to go to attract VIPs away from Echo.

Given that international VIP revenue comprised 27% of its total revenue in the first half of 2015, Echo will likely have to spend hundreds of millions more if it wants to keep attracting VIP customers to The Star.

Pokies paying out

Only generating 4% of total VIP revenue, Echo's Queensland casinos in Brisbane and the Gold Coast – it sold its Townsville casino on 1 Oct 14 – are directed more to the average punter. As such, the company has benefited greatly from regulatory changes by the former Queensland government making it easier to lose money when playing poker machines.

The changes – 'modernisation of the regulatory environment' according to the company – included removing maximum betting limits on each machine and introducing 'ticket in, ticket out' technology which made it easier to transfer any winnings between machines (thus increasing the chances of those winnings disappearing).

Yet these changes are likely to be a one-off benefit to revenues, so Echo is currently spending $345m to upgrade its Gold Coast casino.

Despite the change in state government creating uncertainty over the planned Queens Wharf redevelopment, Echo's Brisbane casino still faces potential future competition from Crown should it win the licence to build a new casino as part of the redevelopment. Even if Echo wins, it will need to invest heavily to build a replacement for its Treasury casino, likely resulting in equity raisings.

Future imperfect

Crown Sydney and a potential Crown Brisbane are still at least 4 years away, though, and Echo will benefit in the meantime if it continues to lure customers to its properties.

However, with the price up 64% since we upgraded to Buy in Echo is worth a shout on 23 Sep 13 (Buy – $2.68) and up 9% since Echo downgraded to Sell on 7 Nov 14 (Sell – $4.02), the stock now trades on a price-earnings ratio of 23, and investors are no longer being compensated for the risks. SELL.