Tabcorp: Result 2019

We had to chuckle when we read chief executive David Attenborough's interview yesterday with the Financial Review. Responding to calls for the Lotteries division to be spun off, Attenborough said 'To think that [Tabcorp] is better separated is absolute nonsense. There is real strength in this diversified gambling business that has been put together through this merger.'

But proponents of the spin-off - us among them - don't doubt the benefits of diversification or even some of the cross-selling opportunities of offering lotteries next to wagering. The trouble is that combining the lotteries and wagering businesses under one roof is a bit like trying to flog a one carat diamond set in a brown plastic setting; it's just a distraction that muddies the look.

On the bright side, the business combination means that Tabcorp's Lotteries division is probably undervalued by the market, and Tabcorp is getting close to our recommended Buy price of $4.00. However, for existing shareholders, spinning-off the Lotteries division would probably see it valued more highly. 

Lotteries shine

Indeed, the Lotteries division was the star performer of Tabcorp's 2019 result - the only performer, in fact. Revenue rose 22% to $2.8bn, with a 22% increase in active players mainly due to a favourable run of large jackpots.

Better yet, because the Lotteries business has mainly fixed costs, operating expenses only rose 9%, which caused a 37% spike in earnings before interest and tax (EBIT). 

Whatever sparkle Lotteries brought to the ring, the Wagering division was nothing but plastic. Revenue fell 4% to $2.3bn. This was particularly disappointing because promotional offers to punters increased during the year, but this wasn't enough to attract new players. 

Digital turnover - a bright spot over the past couple of years - was also lacklustre, rising just 8%. There was a market slowdown in the second half of the year, with turnover growth slowing from 11% to 7%.

Management reiterated its expectation for $130-145m of savings and revenue benefits to flow through from the merger with Tatts by 2021, with $57m of that achieved this year. While we think there's a good chance that the company achieves its long-term target, especially the cost-cutting aspect, we do note that $35-50m of the final benefit figure is from 'revenue synergies'. With only $7m having been achieved so far, this component might be overly ambitious. 

The stock trades on a prospective price-earnings ratio of 21 based on consensus estimates for 2020 earnings, and a dividend yield of 4.8%. The share price is down slightly since we reviewed the company in detail a few weeks ago, and we're sticking with HOLD.

Note: The Intelligent Investor Equity Growth Fund and the Intelligent Investor Equity Income Fund own shares in Tabcorp.

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