What could be worse than Tabcorp’s 1% increase in underlying earnings before interest and tax (EBIT)? Realising that EBIT is still 8% below where it was 15 years ago. And what could be worse than that? Realising that the number of shares outstanding has more than doubled since then, leaving the intrinsic value per share significantly lower than it was in 2001.
The reason for this economic bleeding is pretty straightforward: increasing competition. Online operators, such as Paddy Power Betfair, have a significant cost advantage over Tabcorp because they don’t have to maintain costly retail outlets (see Tatts: the lottery that always pays). This means they can still make money, even while charging customers lower commissions.
Wagering better than expected
Keno and Gaming performing well
Approaching Sell price; Hold
With this as a backdrop, it was impressive to see Tabcorp’s betting turnover actually increase 3.8% compared to last year. The result was down to a 12% increase in digital turnover – gambling via the Internet and mobile apps – which more than offset a 1% decline in retail betting and a 7% decline in call centre turnover.
Still, the 12% growth in digital turnover is nothing against the 39% achieved by Betfair's Australian operations in the 12 months to December. With Betfair almost invariably offering better odds than Tabcorp due to its lower cost structure, we expect Tabcorp to continue to lose customers to Betfair.
Total revenue increased 2% to $2.2bn, though net profit fell 49% to $169m. Most of that fall, however, was due to last year’s inflated earnings due to a one-off $150m tax settlement. On an underlying basis, net profit increased 8.5% to $185m, due mainly to a lower tax rate and less depreciation and amortisation expenses. Again, pretty impressive given the company’s main division has a business model that we would bet our boots is going out of business in the long term.
Keno and Gaming
The company’s Keno division, which accounts for 14% of EBIT, had a good year, with revenue up 5% to $208m. The company has made progress rebranding its Keno operations, and the pooling of jackpots between NSW, ACT and Victoria has meant bigger prizes, which, in turn, attracts more players. A new Keno app was launched and the NSW licence was extended to 2050.
|Year to 30 Jun||2016||2015|| /(–)
|U'lying EBITDA ($m)||516||508||2|
|U'lying EBIT ($m)||337||334||1|
|U'lying NPAT ($m)||185||171||9|
|U'lying EPS (cents)||22.4||21.7||3|
|Final dividend||12 cents, fully franked (up 20%)
ex date 9 Aug
The Gaming Services division, which supplies pokies machines and services to various gambling venues, also performed reasonably well. The number of gaming machines under contract increased 9%, mainly due to expansion in NSW. Revenue rose 8% to $107m, though EBIT grew a more modest 4%.
Tabcorp recently announced its intention to buy gaming management system operator Intecq for $115m. We’re normally sceptical of growth by acquisition, but this case seems reasonable. Intecq will add around 55% to Gaming Services revenue, and around half of that is a recurring stream of maintenance payments.
Tabcorp should benefit from the extra scale by cutting out duplicate costs and, what’s more, the offer price looks fair. Management expects Intecq to add around $20m to EBITDA in the year following completion, which implies a price of less than six times EBITDA (Tabcorp itself trades on an enterprise value to EBITDA multiple of around 10). The deal still needs approval from the regulators and Intecq shareholders so it isn’t in the bag just yet.
Tabcorp’s stock currently trades on an underlying price-earnings ratio of 21. It’s by no means cheap, especially given our lack of faith in the Wagering business, so we note our recommended maximum portfolio limit of 5%. Nonetheless, this result was better than we expected and the Gaming and Keno divisions are moving in the right direction. We’re increasing the price guide slightly to give the stock more leeway before we consider a downgrade and – for now – we continue to recommend you HOLD.
Disclosure: The author owns shares in Paddy Power Betfair PLC.