Regulatory Risk On The Rise For Endeavour Group

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Analysts assess the impact on Endeavour Group of new regulatory reforms introduced by the Victorian government.

-Regulatory risk rises for Endeavour Group after new reforms by government of Victoria
-Implementation delays and uncertainties make forecasting difficult
-Following yesterday’s share price fall, some brokers see value
-Risks posed by other states and more stringent reforms

By Mark Woodruff

Brokers generally lower their 12-month target prices for Endeavour Group ((EDV)) as regulatory risk for the Hotels business has risen following the Victorian government's announcement of new reforms on electronic gaming machines.

Wider risks to group earnings could also emanate from other Australian states with similar or more stringent reforms, such as the default limits being introduced in Tasmania by the end of 2024.

The company operates a retail drinks network across Dan Murphy’s and BWS stores as well as a portfolio of licensed hospitality venues via two segments: Retail and Hotels.

By the end of 2023 the Victorian government will introduce mandatory pre-commitment limits (i.e. a self-nominated maximum loss) and carded play linked to patrons’ identities, as well as new load-up limits capped at $100, down from $1,000.

The spin rate for new machines will be reduced to three seconds from just over two seconds and there will be mandatory venue closure periods between 4am and 10am. The latter will be enforced by mid-2024.

There are no mandatory loss-limits prescribed by the regulations and no implementation timeline has been announced.

Given the complexity of changes involved and pending consultation with industry via an implementation working group, the reforms will take some time before commencing, making it difficult for anyone to fully assess the impact on Endeavour’s earnings in the here and now.

The company signed a ten-year gaming entitlement with the Victorian government in August last year, which didn’t include the announced gaming changes, and UBS feels the group may have further options that could include a changing of financial terms.

As a result of these delays and uncertainties, Morgans makes only minor changes to its FY25 earnings forecast, yet downgrades its rating to Hold from Add on the greater regulatory risk, while awaiting further commentary at the FY23 result release scheduled for August 16.

This change by Morgans is the most dramatic made by brokers monitored daily by FNArena; its new target of $5.87, down from $7.30, is now the lowest in the database.

Underweight-rated Morgan Stanley continues to see regulation as a medium-to longer-term earnings risk and reduces the multiple applied to its price/earnings valuation.

This broker feels the introduction of carded play (cashless gaming) will likely lead to the exclusion of the current cohort of users who are opposed to registered play, as anecdotal evidence from loyalty programs and cashless trials in Australia suggest a general avoidance to becoming registered.

On the flipside, an offset to this headwind may occur as more ease of use may attract the younger generation and motivate an increase to their overall play.

While Accumulate-rated Ord Minnett acknowledges a likely fall in Endeavour’s gaming revenue as a result of the reforms, it suspects the impact on the group’s intrinsic value is less severe than the market anticipates, if yesterday’s -10% decline in share price is anything to go by.

This broker, which white labels research on Endeavour from Morningstar, believes NSW will follow with its own reforms. When these NSW reforms are combined with the new Victorian regulations, it’s thought overall earnings for the group will fall by a moderate -7% from fiscal 2025, with the valuation impact partially offset by the time value of money.

The current share price screens as undervalued, in Morningstar's view, and while the reforms are expected to weigh on long-term earnings, around 60% of earnings derive from Endeavour’s Retail segment, which is unlikely to be impacted by the new regulations.

Management noted it does not expect a material impact on gaming revenue or earnings and Goldman Sachs agrees.

This analyst estimates around 38% of the group’s gaming machines and 30-35% of its gambling revenue derives from Victoria, which only amounts to around 2.3-2.7% of its current FY24 revenue forecast for the group.

Wider long-term risks

A greater danger to group earnings would occur if default limits were introduced.

Currently, Tasmania's default limit of $100 per player per day is the most extreme of the Australian states and would significantly impact industry profitability if implemented more widely, highlights Macquarie.

This broker suggests the new load limits, lower spin rate and shorter trading hours are manageable for Endeavour.

The proposed new regulations by Victoria are a reminder of the regulatory risk that remains for the group around gaming, cautions UBS, and follows announcements in Tasmania regarding mandatory pre-commitment from the end of 2024, as well as the cashless gaming trials that are beginning soon in NSW.

Macquarie notes the increasing risk of the government in Queensland implementing similar changes, noting the state is Endeavour’s second largest electronic gaming machine exposure.

At the same time, this broker points out gaming regulation is a slow-building risk, with changes likely be slow as governments need time to determine how to best offset the associated decline in tax revenue.

FNArena’s daily monitoring of Endeavour Group consists of five brokers with two Buy (or equivalent) ratings, two Holds and one Sell.

The average target price of the five brokers falls to $6.20 from $6.71, suggesting nearly 9% upside to the latest share price.

Buy-rated Goldman Sachs (target $7.50) and Jarden (Underweight; target $6.40) are not monitored daily. Jarden is yet to update in the wake of the new Victorian government reforms.

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