Australia | Aug 07 2017
Brokers welcome the new focus on domestic assets at Crown Resorts but are unimpressed with the near-term outlook.
-Main positive is the $375m buy-back to supplement existing capital management
-Net profit estimates downgraded as company has signalled a step up in the tax rate
-Is the cost reduction story largely over?
By Eva Brocklehurst
Crown Resorts ((CWN)) has completed an eventful year, with a renewed focus on domestic assets. International investments have been exited and VIP operations in China have been wound down. The business has been simplified through asset sales, instead of the initial strategy which was to de-merge international business and launch a real estate investment trust for the hotel assets.
Nevertheless, brokers were disappointed with the FY17 results, which were boosted by a $15m investment gain. Earnings were negatively affected by a -49% fall in VIP volumes and a decline of -1% in main floor revenue. An aggressive cost reduction program meant operating earnings (EBITDA) declined -8%. Australian casino earnings declined by -11% on a -13% decline in revenue.
The company guided to an effective future tax rate of 30% versus 22% and indicated net interest expense will be higher than expected, given the maintenance of gross debt. No significant cost savings are expected in addition to those already achieved. The main positive aspect of the announcement was another $375m buy-back to supplement existing capital management.
Deutsche Bank reduces earnings estimates by -21-26% to reflect the net impact of lower earnings across Crown Melbourne, Crown Perth and Aspinall's (UK) as well as higher net interest and tax expenses. The broker notes the consumer environment is soft in both Perth and Melbourne but gambling expenditure appears to have improved in the last 2-3 months on the east coast.
The broker expects the company to struggle in the VIP market, as it is re-evaluating its VIP strategy and has closed a majority of its international offices. Following an extensive review of funding alternatives for the Alon project in Las Vegas the company has determined it will not proceed. Alternatives will be explored to optimise the value of the investment in Alon, including a outright sale.
Citi's FY18-20 earnings estimates are trimmed by -2-2.5% largely because of reductions to growth assumptions for the main floors of Melbourne and Perth. This is partly offset by upgrades to VIP in Melbourne and digital forecasts. The broker no longer expects further capital management in the near term, given the buy-back just announced.
UBS calculates around -9% of its downgrade to earnings estimates of -17% in FY18 and -14% in FY19 is related to the change in effective tax rates going forward, as the business generates less income from its offshore businesses. The remainder of the decline is attributed to ongoing weakness on the main floor in Perth and higher interest costs, as the company attempts to repair an inefficient balance sheet caused by the illiquidity of its subordinated notes.
Credit Suisse believes the stock is likely to retain an elevated multiple because the balance sheet is currently under-geared and there are expectations of more capital returns. Moreover, Crown Sydney has value but no earnings as yet. The broker downgrades operating earnings by -8% principally because of a more conservative outlook for VIP and a higher cost base in Perth.
Net profit estimates are downgraded further, by -18%, because the company has indicated its future tax rate will approach the Australian statutory rate of 30%. The broker also substantially reduces dividend forecasts as the company has, instead, announced another share buy-back.
Morgan Stanley believes the outlook for Australian VIP and mass market revenue is weak and cost reductions are largely factored in. Moreover, there is a risk of higher capital expenditure associated with Crown Sydney. Support should come from the buy-back and the balance sheet. The broker questions why a higher tax rate of 30% is expected when its major divestment, the Melco stake, should not affect the tax rate.
Australia's consumer environment is under pressure from falling incomes and this should mean mass gaming growth remains weak. The broker observes 6-12 month leading indicators in the macro VIP environment are showing signs of slowing and this could have an impact on recovery. Capital expenditure for Sydney has been pushed out and is expected to step up significantly in FY19-20.
FY17 results were below Ord Minnett's forecasts as a result of VIP weakness. Uncertainty around the corporate strategy has persisted but the broker believes cost savings, share buy-backs and debt capacity will allow Crown to undertake significant changes. The broker is increasingly confident that management will focus on shareholder returns and domestic growth, to underpin value.
More Cost Reductions?
UBS believes a simplified structure means the company can remove -5% of its cost base by FY18. While FY18 guidance already implies -$38m of corporate cost reductions the broker believes another -$50m could be removed from domestic casino assets.
In the broker's opinion a return on Crown Sydney will be predicated on the VIP market closer to the FY22 opening, while Melbourne and Perth will be able to achieve a higher return on investment capital over the next three years amid a slowing of capital expenditure and renewed focus on cost. UBS believes the company can pay a $0.60 dividend each year and comfortably fund its current capital expenditure requirements.
The cost reductions story came to fruition in FY17, Morgan Stanley asserts. Given labour costs can only be reduced by so much and be sustainable, and corporate costs are expected to increase in FY18, there is little more the company can do, in the broker's opinion.
Following the repositioning of the business Goldman Sachs expects earnings will be driven by consumer spending and efficiency gains. A gradual cyclical recovery in expenditure is expected of which Crown should be a beneficiary. The broker, not one of the eight monitored daily on the FNArena database, maintains a Buy rating and $14.30 target and prefers to gain exposure to a recovering consumer through Crown versus the retail names.
There are three Buy ratings and four Hold on FNArena's database. The consensus target is $12.75, suggesting 7.4% upside to the last share price. The dividend yield on FY18 and FY19 forecasts is 4.9% and 5.4% respectively.
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