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4 stocks to get on your table

Glenn Freeman  |  10 Jul 2017Text size  Decrease  Increase  |  

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This quartet of gaming stocks, three of which hold economic moats, each have pockets of potential for long-term investors.


The green-lit merger of Tatts Group (ASX: TTS) and Tabcorp (ASX: TAH) late last month book-ended a hectic six months for both entities. The deal has see-sawed several times under the scrutiny of the Australian Competition and Consumer Commission (ACCC) and Australian Competition Tribunal--swinging from an each-way bet to ultimately emerge as an almost sure thing (pending the 11th-hour ACCC appeal mentioned below).

Upon completion of the $11-billion merger, Tabcorp would emerge as the winning bidder, a deal which is supported by Tatts management. The lotteries operator--60 per cent of its revenue is from lotteries--has encouraged its shareholders to accept the offer.

With the wagering industry under pressure from digital betting--the likes of Sportsbet, William Hill, Ladbrokes, and others--Morningstar equity analyst Daniel Ragonese believes the more sustainable earnings of lotteries is a major attraction for Tabcorp.

"Tabcorp's operating expenses increased during the year to around 23 per cent of revenue, reflective of larger investment in risk management, strategy, digital, and technology. However, over the long term this should be more than offset by the expected merger benefits," says Ragonese.

Tabcorp's own guidance to investors anticipates $130 million in "annual cost synergies" due to reduced corporate overheads, and better efficiencies in IT infrastructure and retail functions.

"These earnings benefits should be realised in the first full year following completion of the integration of the businesses," Ragonese says.

The increased scale benefits from the merging of both business's wagering operations is another key reason for the proposed merger--as both have struggled to maintain their operating margins in the face of sustained competition from the proliferation of smaller, digitally-focused players from offshore.

Wagering market share


Source: Morningstar Estimates, Company Data


The 11th hour

Though the merger of Tatts and Tabcorp remains more likely than not to proceed, it emerged on Monday the ACCC has appealed the ACT finding. It alleges the tribunal made three errors in its reasoning.

Tatts is assigned a narrow moat by Morningstar on the grounds of the earnings resilience from the long-licence duration lotteries division, which accounts for around 60 per cent of business unit earnings.

Tabcorp's own narrow moat is due to its status as "the sole pari-mutuel operator and exclusive provider for retail in New South Wales and Victoria". Pari mutuel is a betting system in which all bets of a particular type are pooled, with taxes and the "house-take" removed.

Both are regarded as close to Morningstar's fair value--both Tabcorp and Tatts were around 20 cents overvalued at press time.


Crown Resorts (ASX: CWN) and Star Entertainment Group (ASX: SGR) occupy other territory within the gaming landscape--though Crown crosses with its smaller CrownBet business. Both Crown and Star are bricks-and-mortar casinos, the former strongest in Melbourne and Perth, the latter in Sydney, Brisbane, and on the Gold Coast.

Crown has refocused on its domestic business in recent years, having sold down its stake in Melco Crown. In December 2016, Morningstar equity analyst Ravi Reddy described this development as a positive, "as it reduces exposure to the volatile Macau gaming market, and an uncertainty around Chinese policies towards gaming".

He also noted the "side benefits" of lower gearing and reduced development risk.

Crown Resorts operates strongly-performing casinos in Melbourne and Perth, both boasting impressive EBITDA margins of close to 30 per cent.

"Management has a track record of consistent reinvestments into the properties, resulting in peerless property quality, stable visitor growth, and proven earnings resilience. While the VIP, or high-roller, business introduces some volatility into the consolidated business mix, the massive VIP turnover of more than $50 billion per year provides some stability to the win rate," Ragonese says.

Star generates around 70 per cent of group earnings from its Sydney casino, though Crown's entry into Sydney in 2021 looms as a sizeable threat. An operator of three casinos in Australia's most populous cities, "Star has significant long-term exposure to the rising Asian middle-class," says Ragonese.

"There is considerable operational upside in terms of top-line and margin growth after an extended period of suboptimal performance and underinvestment in the casinos," he says.

Given its centralised exposure to the Star casino in Sydney, generating around 70 per cent of group earnings, it is not awarded an economic moat--largely due to the threat Crown will pose from 2021, when it will have a competing Sydney casino.

More from Morningstar

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Glenn Freeman is a Morningstar senior editor.

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