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5 reasons to be positive on this ASX gaming stock

Nicholas Grove  |  21 Mar 2017Text size  Decrease  Increase  |  

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It wouldn't be hyperbole to say that ASX-listed casino operator Crown Limited (ASX: CWN) has attracted its fair share of controversy and attention over the past several months.

In October 2016, 18 of its employees were arrested and detained as part of an anti-corruption crackdown on the gaming industry by the Chinese government.

Subsequently, casino operators across Australia felt the impact of these arrests in the form of weaker VIP turnover in the fiscal half year ended December 2016.

Morningstar equity analyst Ravi Reddy said Crown felt the most pain among these operators, with its Australian VIP revenue down 45 per cent on the same half in the previous fiscal year.

However, despite the lacklustre start to the 2017 fiscal year--and while he expects further weakness in the second half of the year--Reddy says there is still a lot to like about Crown.

Also, in a recent note where he revisits his investment proposition on the stock, UBS analyst Matt Ryan says he is positively disposed towards five facets of the "new look" Crown Limited.

1) Playing monopoly

The first of these is the company's simplified operating structure, and the strength of Crown's monopolistic casinos, Ryan says.

It is the position of these casinos in Melbourne and Perth that Morningstar's Reddy believes underlies Crown's narrow economic moat, which denotes the company's ability to sustain excess returns over a long period.

"Each of Crown Resorts' properties enjoy a privileged position, with a long-term casino operating licence from the relevant state government," he says.

"This licensing regime creates a legal barrier to entry--an intangible quality that underpins its economic moat."

Reddy also applauds the company's decision to scrap its Las Vegas expansion, pare back its exposure to Macau, and abandon the proposed Crown REIT IPO.

"In our view, these noncore projects have been distractions, and we feel more comfortable now that management will be focused on improving performance at its key domestic operations."

2) Increased ROIC profiles

UBS's Ryan also believes Crown's Melbourne and Perth casinos are poised for increased returns on invested capital (ROIC), with both properties currently operating in an ex-capital expenditure phase of the cycle.

"Crown has been able to negotiate favourable terms for product caps, gaming tax rates and the casino licences/exclusivity," he says.

"We expect that a slowdown in capital expenditure and a renewed focus on costs should allow for an increase in Crown's ROIC at its two major properties."

3) Costs out, margins higher

Ryan also expects Crown to witness higher margins, driven by a forecast 5 per cent reduction in its cost base over the two years to fiscal 2018.

Ryan used rival Star Entertainment's (ASX: SGR) cost-out programme as a precedent for Crown.

"Crown already expects to achieve $38 million in cost savings within its corporate division in fiscal 2017 and we think other cost saving initiatives of up to $50 million are possible at the asset level but may take longer to fully achieve."

4) Revenue rebound

Additionally, Ryan expects Crown to see a rebound in revenue growth from second half of fiscal 2018 as the company cycles through declines in VIP operations.

While Crown's VIP growth was impacted by the arrests in late 2016, Ryan is forecasting a "multi-year decline in VIP volumes during fiscal 2017/18, with the expectation of a recovery in fiscal 2019".

Morningstar's Reddy notes that while Crown's VIP business introduces some volatility into the business mix, the massive VIP turnover of more than $50 billion per year provides some stability to the win rate, and protects the company against "single-whale risks"--or wins from high rollers who wager large amounts of money in a single visit.

5) Balance sheet strength

Ryan sees a final positive in the form of Crown's balance sheet strength.

Reddy believes the company's credit profile has improved following the reduction of its stake in the Melco Crown venture in Macau.

He points out that as at 30 June 2016, Crown's gross debt was $1.7 billion, gearing stood at 2.0 times, and interest cover at 3.2 times.

He expects Crown's debt metrics will improve further, with $800 million of the proceeds from the sale of Melco Crown shares to be put towards reducing debt.

Reddy currently has Hold recommendation and a fair value estimate of $13.00 on Crown Resorts.
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Nicholas Grove is a Morningstar journalist.

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