Tabcorp Faces Uncertain Outlook

This story features TABCORP HOLDINGS LIMITED. For more info SHARE ANALYSIS: TAH

By Chris Shaw

As online gaming continues to grow globally some of the bigger international players such as Betfair, Paddy Power and Intralot have looked to the Australian market as one offering growth, Morgan Stanley taking the view this increased competition will put local gaming groups such as Tatts Group ((TTS)) and Tabcorp ((TAH)) under additional presure, particularly as it relates to margins.

This is especially the case as the broker notes online gaming is continuing to lift its market share of the wagering market at the expense of the state-based totalisator operators, a trend looking likely to continue given Paddy Power for example recently acquired 51% of Darwin-based Sportsbet, which in turn has made an offer to acquire competitor International All Sports ((IAS)).

But other growth options exist for the foreign players, as Morgan Stanley points out there are potentially three gaming licences going up for sale in the future – TOTE in Tasmania, the Victorian wagering licence and NSW Lotteries, though the last one appears the least likely to see a sale anytime soon.

With respect to all three the broker estimates a purchase at a reasonable price by either Tattersall’s or Tabcorp would prove to be earnings accretive, by as much as 12% for Tatts with respect to TOTE Tasmania and slightly accretive for both companies with regards to NSW Lotteries. The broker notes its assumptions are based on a number of unknowns such as the earnings multiple on which the asset is purchased and whether or not any deal is fully debt funded, so they are only approximates.

Given the potential for earnings accretion the broker takes the view there is likely to be solid competition for the assets and it expects at least one will end up in the hands of one of the overseas players given such a purchase would allow them to further cement their position in the Australian market. At the same time this would make it tougher for the likes of Tatts and Tabcorp to grow profits given the loss to earnings they will face in a couple of years when their existing Victorian wagering licences expire.

Given such an industry outlook, yesterday’s full year profit result from Tabcorp is of interest, the group posting a normalised net profit for the year of $496 million. Macquarie notes the result was right in the middle of a tight consensus range.

In the broker’s view the result itself pales in importance when compared to the game the company is playing with respect to its future, which involves not only Tattersall’s but the Victorian and Tasmanian governments, corporate bookmakers and its recent move into casinos via Star City.

In Macquarie’s view the casino move highlights the group’s struggle to find growth given the upcoming end of its poker machine franchise in Victoria, which sees it adopt a cautious view on the company’s prospects even allowing for the fact it could well be successful in one or more of its possible moves.

In terms of post-result reactions, both Citi and Bank of America Merrill Lynch have lowered their earnings forecasts for coming years, by 3-4% in FY10 and by almost 6% in FY11 in the case of Citi. The changes reflect expectations of higher costs in the wagering and casino divisions as well as lower revenue assumptions given the slowing in the Australian economy. The FNArena database shows consensus earnings per share forecasts of 77.7c in FY10 and 81.2c in FY11.

One issue in Citi’s view is the company is being left to bear the brunt of the costs involved in reforming the wagering market as neither the NSW or Victorian governments are helping, with this coming at the same time as the group is having to become more aggressive in fighting to retain market share from lower cost operators based in the Northern Territory.

This sees the broker retain its Hold rating, one matched by Merrill Lynch. Overall the FNArena database shows a total of three Buy ratings, six Holds and only one Underperform recommendation courtesy of Macquarie.

Credit Suisse argues despite the pending loss of the Victorian licences the stock is still a Buy on valuation grounds, as post the profit result it lifted its long-term operating profit estimates and this resulted in its price target increasing to $8.60 from $8.00.

UBS agrees, noting while the result was disappointing with respect to the businesses that will remain post 2012 these assets are attractive and the stock is equally attractive with respect to its current valuation, even allowing for the broker’s 50c cut in its price target to $9.20, which is the highest in the database. The average price target is $7.55, with Macquarie the least aggressive with a target of $6.30.

Shares in Tabcorp today are slightly stronger despite a weaker overall market and as at 1.35pm the stock was up 8c at $7.11. This compares to a trading range over the past year of $6.05 to $9.25.

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