Constrained Outlook For Gaming

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-Rising petrol prices affect demand
-Demand drop in eastern states
-Crown the casino favourite
-Tatts more resilient than Tabcorp
 

By Eva Brocklehurst

Is there a weakening of the gaming outlook in Australia? Demand in NSW, Queensland and Victoria dropped in June and rising petrol prices appear to be having an impact. On this basis, BA-Merrill Lynch has seen fit to reduce earnings forecasts for the gaming sector.

For Tabcorp ((TAH)), Tatts ((TTS)) and Echo Entertainment ((EGP)) this means a reduction of 2%, 1% and 3% respectively for FY14 estimates. The broker's central view is unchanged. Gaming is expected to be relatively resilient in a downturn, although not completely unaffected. Merrills' favoured stock is Crown ((CWN)) where operational control and the exposure to the Melco JV should mean growth can be sustained throughout FY14 and FY15.

Victoria's gaming has been consistently soft while NSW and Queensland produced a sudden decline late in FY13. Gaming spending showed the first decline in June across Queensland in two years. There was some government stimulus last year, which may have supported prior comparisons, but Goldman Sachs thinks rising petrol costs and weak consumer confidence are doing the damage. All up, there are concerns about household disposable income being constrained enough to provide headwinds to the sector.

Wagering could have been affected by inclement weather in NSW late in the second half of FY13. TAB thoroughbred data pointed to a 11% decline in the pool size in June. Lotteries were resilient and this should help Tatts. Goldman prefers Tatts to Tabcorp for this reason. Merrills thinks a key theme this year will be an improved online offering from Tabcorp but there are potential risks with the renegotiation of the media rights fee in FY14. Strong jackpot sequencing and acquisitions will drive growth for Tatts, in the broker's opinion, but it's likely to be muted.

Merrills has an Underperform rating on Tabcorp, because of the tightening competitive landscape and stretched balance sheet. Valuation is considered full. Goldman retains a Sell rating on Tabcorp as well, because of low earnings growth – and that balance sheet. There are also structural challenges in growing the retail sales channel in the face of online competition.

Goldman Sachs has also trimmed earnings forecasts because of the recent Australian economic data, which points to a weakening domestic economy with unemployment rising. Domestic casino earnings forecasts for Crown and Echo have been eased. Goldman also finds Macau is resilient, with mass market the key driver of future growth and Crown is well positioned to leverage this growth. Crown is also this broker's key stock in the sector.

Merrills' Macau gaming analysts believe the rise in Chinese disposable income should help sustain the Melco Crown JV growth at 8% for FY14. Merrills agrees that Crown will not be immune to Australian consumer headwinds and expects Melbourne will have slow to flat growth in the second half of FY13. Perth is expected to be slightly more robust but pressure will mount in FY14. Despite this, Crown's operational excellence is expected to stand it in good stead.

Echo's outlook is expected to be constrained, given weakening consumer spending, and Merrills admits FY14 forecasts have a fair degree of support from the assimilation of a major cost cutting program. It's the strategic response to Crown entering the Sydney market and how plans for Queensland redevelopment and exclusivity play out which will dog Echo in the months ahead. Merrills thinks the stock could be a value trap, with some support from an undemanding valuation.

Gaming machine manufacturer, Aristocrat Leisure ((ALL)) has a tough outlook in the US market, in Goldman's opinion. Despite upgrading valuation, the broker is reluctant to be more constructive because of weak underlying industry demand. The falling Australian dollar is a positive for the stock as US earnings are translated, but the US slot machine industry is quite subdued. Aristocrat's market share is significantly higher in US regional casinos – at 15-16% – versus its share on the Las Vegas strip of 5-6%. The stock is therefore exposed to the weak financial results in the regions and Goldman's US gaming team has made downward revisions to most of the regional operators, given results to date. Other manufacturers also have good product in the market which makes for intense competition.

Merrills points to the US for Ainsworth Game Technology ((AGI)), where the company will need to deliver on its momentum to sustain the robust outlook. The broker expects that the company's strongly performing products should drive increased traction in the market and Ainsworth would continue to demand a premium price relative to other games. There is scope for the company to expand its market through licensing in new jurisdictions. Merrills expects the strong product performance will drive growth in FY14 and channel checks in Australia indicate the stock is gaining significant market share. The balance sheet, strong free cash flow growth and potential for a dividend increase all support Merrills' Buy call.

Gambling advertising was up 27.6% for second half of FY13 in Australia, as bookmakers vied for customers in a competitive space. Taking out election year political advertising, gambling was the fastest growing market category in the half year to June. Goldman believes the strong growth in gambling advertising reflects a very competitive wagering and sports betting market with companies striving to grow share in an increasingly crowded space. Here, Tabcorp is the most exposed in 2013 as the broker estimates 57% of Tabcorp's earnings will be generated from wagering/sports betting ,compared with Tatts at 31%. Tabcorp has guided to a 1% wagering cost increase or the second half and, while the broker expects the company to focus on delivering this outcome, it may be at the cost of market share.
 

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