Last drinks at Echo

Last year casino operator Echo Entertainment Group was in the headlines for all the wrong reasons. The company's $1bn refurbishment of The Star casino hadn't produced a satisfactory increase in profits and then James Packer twisted the knife by announcing that Crown Resorts build a rival casino on the other side of Darling Harbour as part of the Barangaroo redevelopment.

Echo was also forced to bid for the redevelopment of Queen's Wharf in Brisbane, as the government blamed it for not investing enough in its Queensland casinos. Win or lose Echo's Treasury Casino in the heart of Brisbane was no longer going to be the monopoly it is today.

With the share price falling 38% from a high of $4.35 in May 2012, though, we smelled an opportunity and upgraded the stock at $2.68 on 23 September 2013 in Echo: Worth a shout.

Investment case
 

The investment case was simple. First, Packer's new casino in Sydney wasn't going to steal all of The Star's business. Barangaroo will be a VIP casino designed to attract wealthy and high stakes gamblers, particularly across Asia. Initially at least, it also won't be permitted to operate poker machines. There are also membership restrictions, so you can't necessarily show up on a whim dressed in your Sunday best and expect to get a seat at the blackjack table.

Second, there were six years to improve the performance of The Star before Barrangaroo opened. The Star had been poorly managed which meant there was loads of potential to increase profits, which we've recently seen under new chief executive Matt Bekier. Earnings are expected to increase around 30% this year.

Since the initial recommendation the share price has increased 42% and along with dividends has produced a total return of 45% in barely a year. Mr Market even gave you lower prices to take advantage of, but having now regained his senses there's no longer a large margin of safety and we're selling out.

Sit tight?
 

There are two reasons why we could be getting out too early. First, the performance of The Star continues to improve at a rapid clip, and Bekier may be able to extract plenty more value from the $1bn refurbishment and a bunch of sensible operational changes, including much better marketing offers that take advantage of The Star's top-notch restaurants.

Second, Echo's joint bid to redevelop Queen's Wharf in Brisbane could prove a huge success. The problem is we don't know whether the bid will win, how much capital the company will need to raise to build the new casino and surrounding entertainment and shopping destinations or what the returns will look like. Echo's track record of adding value isn't great, though Bekier is untested as chief executive in this regard.

You might want to hang on to see how things pan out, but the reason we bought in has been vindicated, the value has been realised quicker than we expected and there's still a lot of uncertainty surrounding the Sydney and Brisbane casinos. Our official Sell price is $4, but we're happy to lock in profits at prices close to that. SELL.