Tag Archives: Gaming

article 3 months old

Donaco Offers Upside As New Casino Readies For Opening

-Capacity enlarged greatly
-Tapping Chinese tourist growth
-Strong growth in returns envisaged
 

By Eva Brocklehurst

Donaco ((DNA)) is opening a new 5-star hotel and casino in the north of Vietnam. Brokers are excited. CLSA is initiating coverage of the stock with a Buy rating. The broker thinks this casino, scheduled to open in May, will be better exposed to gambling popularity across the border in China, tapping a market that the company was previously unable to service properly, given capacity constraints at existing operations.

CLSA's base case forecasts are for FY16 earnings of $80m, valuing the company at 7.7 times that amount, or $1.69 a share, a 30% discount to regional peers to reflect execution and regulatory risks. This base case assumes both VIP and mass market table yields decline sharply once the new casino opens, in response to a five-fold increase in tables. Despite this, the broker's analysis suggests yields will recover quickly, bottoming in FY15 and largely recovering by the end of the second half of 2016. CLSA acknowledges the valuation is effectively reflecting a casino that is not yet open, albeit with some indications from the existing, substantially smaller, casino.

The existing Lao Cai complex has been operating since 2003, with 34 rooms at 3-star, eight gaming tables and 36 machines. The new complex will boast 428 rooms at 5-star standard and have floor space to accommodate at least 50 tables and up to 300 machines. The opening was delayed to May, originally set for March, because of administrative hiccups. The existing casino has been forced to rotate VIP junkets, with its rooms completely booked out so the broker believes the new property should attract materially higher spending from Chinese residents. There is limited competition because Macau is inaccessible to many Chinese. The Lao Cai casino is readily accessible to a large potential customer base across the border in China, where casinos are banned. For the 46m residents of Yunnan province, and a number of other provinces, the Lao Cai casino is their closest legal gambling destination.

Infrastructure developments on both sides of the border, attractive VIP commission rates and the impending boom in Chinese tourism all add potential. In FY13 80% of revenue at the existing casino came from lower-margin VIP plays but still compared favourably to other casinos, thanks to low taxes and labour costs. The broker expects margins to approach 30% at the new property, benefitting from economies of scale and leverage. Of course, there's regulatory risks that go with the gaming territory but CLSA believes the returns outweigh these. The broker notes strong demand for gaming is evident in the region, not only from Chinese residents but also Singapore, Korea, Australia and the Philippines. CLSA is forecasting a 13% compound average growth rate across these markets over the next two years. Moreover, the supply/demand balance, or imbalance, is highlighted by the rate at which yields recover after new volume is added to the system.

Comparing forecasts to regional peers table yields in FY13 and based on FY16 forecasts, Lao Cai ranks well below Macau but ahead of Cambodia and the Philippines. CLSA thinks FY16 will be the best year against which to value the company, given FY15 will involve the ramp up of operations and fine tuning of marketing directed at China. BA-Merrill Lynch notes significant growth in the company's net table revenue in the first half. The broker believes the stock was always going to be an investment case from FY15 onwards and is confident in the growth potential. A price objective of $1.57 could prove to be conservative and Merrills retains a Buy rating.

Reflecting the conservative expectations, Merrills' forecasts assume $44,000 in net table revenue in FY15, versus the current $55,000, to reflect the increased numbers of tables. Scaling up table numbers from the initial 40 expected in July, to 50, provides upside revenue opportunity. Any liberalising of government controls on Vietnamese attendance will also add value upside. Vietnam current forbids locals to play at the casino but there are potential changes in the wings on that front and Merrills thinks, on a 3-year view, that could be an additional driver of growth. Merrills concurs that it's the focus on Chinese outbound tourism which is the key attraction. The positives for the broker are the robust VIP and slot machine turnover. Revenue from gaming machines grew 60% in the first half, with the new machines seeming to trade at relatively higher returns.

What else is on the company's strategic outlook? Donaco intends to spin out the mobile technology business, iSentric, by April. This is is a welcome move for Merrills, as the broker thinks the division lacks a connection with the main casino offering. The divestment will occur by way of sale to an ASX-listed company, leading to a planned in-specie distribution to shareholders. The $12m valuation of iSentric holds up well, in the broker's view, comparing with the acquisition price of $8.5m in June 2013.
 

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article 3 months old

Echo Entertainment Update Resonates Poorly

-Poor recent trading momentum
-Subdued consumer again blamed
-Lacks clarity on investment value
 

By Eva Brocklehurst

Unfortunately, Echo Entertainment ((EGP)) doesn't have a Macau casino investment to offset the subdued environment in Australia. The company's momentum has taken a jolt in the last month or so, with its casinos affected by a sharp slowdown in the volatile VIP segment. The subdued update delivered at the company's AGM was not that surprising to most brokers, given the tough background cited by several others in the gaming sector, including soon-to-be Sydney competitor, Crown ((CWN)). 

Echo is a pure casino story, with its four properties - Treasury in Brisbane, Jupiters in Gold Coast and Townsville and Star City in Sydney, enjoying monopoly status - for now.

The company has indicated that growth has slowed significantly in recent weeks after a strong start to FY14. Normalised gross revenue is down 3.5% to October 31 2013. It's the VIPs that have dropped off, but comparatives are also affected negatively by the shift in marketing strategy last year and a large pay in slot machine jackpots in October. Then there's the time-worn comments about subdued consumer spending.

In Queensland, the company has stated it will consider investment levels of around $1.5 billion to refurbish its properties and will progress with proposals to the Queensland government for the Brisbane precinct redevelopment. The quantum of that investment amount did cause the market to catch its collective breath. BA-Merrill Lynch notes the Queensland properties in Brisbane and Gold Coast were due for re-development and management had flagged this for some time. It's just that the visibility regarding the potential return on that investment is lacking, as commentary from the Queensland government has signalled the potential for new entrants in the Brisbane market.

Merrills admits the company needs to show a high profile commitment to its properties and the long-term viability of the business in the face of any competition threat in Brisbane but further news on such competition is not expected in the near future. The company is also dogged by uncertainty because of competitor plans in Sydney. The Star complex has recently been revamped but will be competing with Crown's Barangaroo from 2019.

In Merrills' opinion there's no catalysts for a near-term re-rating and also less strategic value in the stock now that Crown has made an exit from the register. Merrills has downgraded earnings forecasts in the wake of the AGM update, by 6% for FY14 and 8% for FY15, but concedes there is a lot that's discounted in the current valuation.

UBS has also lowered forecasts and assumes 5% earnings growth for FY14. Whilst Echo has valuation appeal, the broker thinks recent comments by the Queensland government add a layer of uncertainty in terms of the potential for new entrants in the Queensland market. The company is also facing uncertainty in terms of Crown Sydney's impact on Star's earnings from FY20/21. Echo trades on a FY14 price earnings multiple of 14.8 times according to UBS estimates, a discount to Crown and Sky City. On a FY14 enterprise value/earnings estimate, Echo's 6.1 times multiple compares with 8.8 times for Crown (ex Macau) and 9.2 times for Sky City.

Macquarie expects earnings growth in the first half of 10.7% and believes that comparatives will get better over the rest of the year. The broker is content to retain an Outperform rating, although expects poor trading momentum and concerns over the investment in Queensland to weigh on the stock near term. UBS also has a Buy rating. As it stands on the FNArena database there are three Buy, four Hold and one Sell (JP Morgan). The consensus price target is $2.91, suggesting 18.6% upside to the last share price and compares with $3.00 ahead of the AGM.
 

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article 3 months old

Crown’s Jewel Is Macau Dividend

-Macau holds the growth key
-Aust casino revenue slows
-MPEL dividend potential excites
 

By Eva Brocklehurst

Casino operator Crown ((CWN)) is increasingly depending on the Macau gambling connections to make the case for growth. The AGM update confirmed domestic trading is flat. What has piqued interest is that the AGM commentary also alluded to remarks from MPEL - the Macau gaming joint venture in which Crown has a one third stake - that a review of distribution policy is nigh.

BA-Merrill Lynch is confident Crown's broad portfolio and ability to control operating expenditure will stand it in good stead and offshore growth will insulate against the domestic headwinds. The AGM commentary has also confirmed MPEL public commentary that a dividend policy revision could occur in 2014. Merrills' model now assumes an arbitrary 20% pay-out from MPEL. Back home, main floor gaming (MFG) is struggling and it's clear consumer spending remains pressured, with rising petrol and utility bills cramping disposable income. There was some disruption from the Melbourne casino's refurbishment but the macro headwinds are considered more critical.

Revenue for the Australian casinos has definitely slowed. For the first 17 weeks of the first half, main gaming floor revenue was flat and non-gaming up 10%. This is below Citi's forecast for main gaming floor growth of 4% but slightly ahead of the non-gaming estimate of 8% in for the first half.

VIP seems to be volatile too, as, while there were better activity levels compared with the second half of FY13, overall it appears to be down on the prior corresponding period. The main driver of the Macau growth story to date has been high rollers but recently growth in the mass market segment outstripped the VIP market. With improving infrastructure, such as rail, CIMB expects this growth will continue and forecasts 31% growth in the mass market in 2013, 30% in 2014 and 32% in 2015. This shift in growth towards the mass market will also be beneficial to the group's margin. Non-gaming trading is also better than Merrills had thought. This is partly from new product but also could be reflecting stronger confidence. The revenue shortfall in MFG seems to the broker to have been largely replaced by non-gaming's relative outperformance, although this is lower margin business.

CIMB expects Sydney's VIP market will continue to grow strongly and that Crown will take a 50% market share once the new site opens. This broker also considers there is a strong likelihood that MPEL will pay a dividend in FY15. The Macau market continues to post strong growth rates and MPEL is winning market share across the main three product segments (mass market, VIP and slots). While there is some earnings risk associated with a slowdown in Perth, given the potential for a MPEL dividend in the short term and the benefits of Crown Sydney coming through in the medium term, CIMB thinks the bias lies to the upside.

Once MPEL initiates a dividend CIMB suspects it will start at a low level and progressively increase. Moreover, the broker suspects MPEL will want to maintain a consistent dividend policy and avoid the volatile patterns of its Macau peers, given the shareholder register. The dividends are expected to be at the low end of the historical pay-out ratio range in Macau and, therefore, 50% of net income which, based on CIMB's forecasts, would be US$414m in 2014 and US$497m in 2015. This would lead to a dividend pay-out to Crown of $143m in FY15. How much is this worth to Crown's valuation? Conservatively, CIMB expects MPEL will continue to grow at 20% over the next three years, with a long-term assumption of 10-15%. The broker also expects the pay-out ratio to rise to 60% in FY18 and 70% in FY20. Should these forecasts prove correct, all else being equal, it would add about $4.00 per share to the valuation.

Despite the softness in local business, Citi is not inclined to change earnings forecasts until MPEL's third quarter result is published on November 5. Crown's new developments are still at the "potential" stage. Sydney remains in Stage 3 of the unsolicited proposals process, discussions on the Sri Lankan casino continue and Crown is waiting for further information from the Queensland government on a new Brisbane casino. While Brisbane is a new focal point, Citi questions whether Crown has the flexibility to undertake all three projects. Estimates show net debt to earnings would exceed 2.5 times during peak capex needed in FY16-17, if all three went ahead. Hence, the MPEL investment would account for over 40% of earnings and should be Crown's principal earnings driver in FY14.

MPEL's City of Dreams is benefitting from its position as a mass-market destination, which is underpinning margin growth. New openings in the Philippines in mid 2014 and Macau's Studio City in mid 2015 should also ensure the strong earnings momentum will continue over the next 2-3 years. All that said, Citi is inclined to stay in Neutral on Crown and thinks the strong run in the share price reflects the improving fundamentals for MPEL but ignores the softness in the domestic properties.

Crown has increased its Buy ratings on the FNArena database since the stock was covered at the FY13 results. There's now seven instead of five. The contrary one is Citi, with a Neutral rating. The consensus price target of $18.09 signals 6.2% upside to the last share price and compares with $17.06 ahead of the AGM.

See also, Stakes Raised In Australian Gambling Market on September 17 2013.
 

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article 3 months old

Weekly Broker Wrap: Insurance, Health Care, Advertising And Gaming

-Not easy building scale in insurance
-Sonic best placed with Obamacare
-Decline in print ads continues apace
-Aristocrat well placed in US market
 

By Eva Brocklehurst

There's no such thing as an insurance cycle, according to CLSA. The definition is too simple. There are many interlocking cycles dependent on the type of insurance, geography and a host of other factors. So that makes for an oversimplification when talking about a cyclical earnings "high" and consequently downgrading the sector. Having said that, CLSA does not dispute that there's a top forming but maintains it's important to de-construct how the down leg will play out. Moreover, what's more interesting is how long it takes for mounting competition to take hold.

The broker speculates that 5-10 years from now, Insurance Australia's ((IAG)) and Suncorp's ((SUN)) market share in personal lines will have dropped to 50% from 70%. Such a reduction does not spell doom, in CLSA's view. Natural perils set the home and motor insurance segments apart. Cars can be moved. Houses cannot. Large capital expenditure is required to cover home insurance. In contrast, cars are, in the broker's words, "a breeze". The analysts, therefore, query why the Challenger brand success in motor insurance should necessarily be translated to success in personal lines. Building an insurance book means facing greater headwinds than the incumbents. This has a big impact on time and capital. Here, IAG and Suncorp have advantages of massive scale. The analysts observe that QBE Insurance ((QBE)) is very good at what it does as Australia's premier commercial insurer and is probably protected against a rapid drop off in rates.

Deutsche Bank believe the competitive threats to IAG and Suncorp are on the rise. Conceding there is little risk these trends will stop these two from delivering record underlying margins in FY14, the broker does envisage risks to top line Gross Written Premium targets. Expectations that margins will hold up out to FY16 does not take enough note of the emerging competition.

Aside from yield, the broker finds limited value appeal in either IAG or Suncorp, with Sell and Hold ratings respectively. IAG and Suncorp averaged 7.1% GWP growth in home and motor insurance in FY13, less than half the 15.7% achieved by competitors in these classes. The broker estimates a collective 180 basis points of lost market share in FY13, leaving IAG with 28% share and Suncorp with 30.7%. Challenger has been most successful in targeting pockets of more attractive risk, in Deutsche Bank's view. QBE is following suite, in a way, looking to target lower risk drivers through Australia's first telematics offering for motor vehicles. Deutsche Bank retains a preference for QBE among general insurers.

While the so-called Obamacare in the United States - actually the US$1.4 trillion Patient Protection And Affordable Care Act - does not replace private insurance, which covers 55% of the population, CIMB suspects the legislation is accelerating a consumer-directed approach to the provision of health benefits. This is a move away from employer-sponsored insurance and shifts responsibility for payment and selection of health care services to employees. Over the past five years, the growth of consumer-directed plans has accelerated.

What does this mean for the Australian health care players in the US market? The broker considers Sonic Healthcare ((SHL)) the key beneficiary in terms of volume expansion in laboratory services and preventative services provided without out-of-pocket expenses. The implications for CSL ((CSL)) are more negative, despite the fact that most products are critical to the treated population. This is because of higher costs, growing discount programs and more restrictions requiring evidenced-based patient outcomes. As well, ResMed ((RMD)) faces increased headwinds from the impact of competitive bidding on the durable medical equipment channel. Cochlear ((COH)) is more disadvantaged than perceived at first glance. Top rate health insurance coverage is required to drive the uptake of implants in adults. Increased excise tax on devices might help too.

Australian agency advertising spending declined in September as political advertising eased in the wake of the federal election. Credit Suisse notes metro advertising spending in newspapers declined 32% in the month and this represents the fifteenth consecutive double-digit contraction and the worst monthly result on record. Regional newspaper advertising spending fell 20% while magazine advertising spending fell 15%. Digital remains the major engine of growth with a 19% year-on-year growth rate. TV advertising growth moderated but remains positive. Metro free-to-air spending grew 1% year-on-year, regional declined 3% and Pay TV spending rose 4%.

Of the stocks in the sector, Credit Suisse likes Seven West ((SWM)) as a strong micro story in traditional media and Ten Network ((TEN)) for its leverage to a recovery in ratings and free-to-air advertising. Carsales.com ((CRZ)) has strong exposure to digital advertising, which is maintaining strong momentum. JP Morgan notes metro TV advertising is returning to more normal trends and the start to FY14 was slightly above Seven West's guidance. Metro newspapers are still challenged and this implies that the difficult conditions for Fairfax Media ((FXJ)) and News Corp ((NWS)) will continue. Moreover, the broker believes that negative revenue trends at Fairfax will require further cost cutting. JP Morgan has an Overweight rating for Seven West and Prime Media ((PRT)) an Underweight rating for Fairfax and SEEK ((SEK)).

CIMB has surveyed the slot machine market at the G2E conference, held in Las Vegas during 24-25 September. CIMB surveyed industry participants to obtain feedback on the new machines that were presented by the manufacturers at the conference. Key findings were that replacement rates in 2014 may be higher than current market is allowing, 34% of respondents indicating replacement rates may increase by 5% year-on-year. New product feedback was positive and Aristocrat Leisure (ALL)) was a clear winner (not rated), with 22% of respondents indicating they were most impressed by its new product. CIMB would not be surprised if there was a shake up of market share in North America and Aristocrat could be a beneficiary.
 

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article 3 months old

Stakes Raised In Australian Gambling Market

-Macau strength benefits Crown
-Aristocrat, Ainsworth well placed for expo
-Mobile platforms grow wagering market
-UK online tax has significant implications
 

By Eva Brocklehurst

Gambling in Australia may be a little subdued but it's going gangbusters in Macau. Macau's gaming growth in the last four months beat Citi's forecasts by 2-4%. This was attributed to increasing visits from mainland China, helped greatly by the completion of the Guangzhou-Zhuhai railway in December 2012. During July and August, Macau's gaming growth rate was 18.7% year on year. Citi expects the strong momentum to continue as visitors can now spend more time at casinos, especially during peak periods such as Golden Weeks. The broker has now raised the forecast 2013 Macau rate of gaming growth to 17% from 15%, expecting it to reach US$44 billion.

It says it all really for Crown ((CWN)) and the benefits arising from the Melco joint venture. Hence the stock is a preferred exposure for Deutsche Bank. Australian gambling expenditure is expected to stay subdued through  the rest of 2013. Perth has the higher growth market in Australia and Crown has introduced some cost reductions to offset the weaker top line trends at Crown Melbourne. The broker suspects general weakness in Australian gambling expenditure can be attributed to the cycling of higher comparatives, deteriorating consumer confidence, increased unemployment, and lower growth in average weekly earnings. Victorian gaming machines have also been impacted by regulatory changes.

Australian gambling expenditure continued to deteriorate throughout the June quarter and this appears to have continued through July and August. The weakness previously seen in gaming machine expenditure has also impacted gaming tables, and Deutsche Bank notes a softening in wagering and keno expenditure. Conversely, lotteries expenditure has remained buoyant, although the broker thinks this can largely be explained by a favourable jackpotting sequence. Another stock that should benefit from a global reach is Aristocrat Leisure ((ALL)). Deutsche Bank notes Aristocrat generates just 27% of group earnings from Australia. The depreciation of the Australian dollar will assist Aristocrat with every US1c change impacting earnings by 1%. Deutsche Bank believes the company is well positioned for the medium term given recent talent retention and acquisitions in the online segment.

The global gaming expo kicks off in Las Vegas on September 23 and BA-Merrill Lynch thinks both Aristocrat and Ainsworth Game Technology ((AGI)) will feature well, with strong product offerings. The demand is more mixed for casinos, in the broker's view. There are many anecdotes of slot floors shrinking, with a focus on quality over quantity, and this suggest the US replacement cycle is unlikely to show any meaningful improvement in the medium term. Pricing is another issue, as there has been a surge in new entrants, with 23 players against just five a year ago.

Still, Merrills believes Aristocrat and Ainsworth are on the right track and growth will have to come from market share gains. Aristocrat is increasingly homing in on the entertainment space while Ainsworth has many new titles and hardware configurations. Underpinning this confidence, Merrills has upgraded earnings forecasts for both companies, by 2% for FY14 in the case of Aristocrat and 0.4% for Ainsworth. The broker prefers Ainsworth, given the stronger forecast 16% compound earnings growth rate for FY13-16 compared with 10% for Aristocrat.

What about Australian wagering? Underlying wagering growth is expected to remain soft in the medium term with market share to be aggressively fought over, according to Merrills. Lotteries are encountering tough comparatives as the number of jackpots at, or above, $15m in the first half of FY14 so far have totalled six. In the prior comparative half there were 21 jackpots at, or above, $15m. Macquarie sees the market as robust despite macroeconomic headwinds. Australia's wagering market recorded revenue growth of 3.8% over the past 12 months.

Macquarie notes the rapid adoption of mobile wagering platforms, a focus on increased yields from all operators, as well as some luck emanating from racing results. In terms of mobile, this is now a $3bn wagering market with Tabcorp ((TAH)) the market leader. Macquarie estimates there is now $3bn of wagering turnover via mobile platforms, up 163% in FY13. Mobile growth is being driven by growing smart phone penetration, its convenience and an improvement in the user experience. So far, there is evidence that mobile platforms are growing the overall market for wagering, as well delivering above-average yields for operators.

From a market share perspective, Tabcorp increased its revenue share by 140 basis points over the past 12 months. This was partly from direct benefits from wholesale turnover after the sale of Tote Tasmania, as well as a growing contribution from its international wagering pool in the Isle of Man. For Tatts Group ((TTS)), its revenue share during FY13 was stable at 17.6%, despite the added benefits from a full year of owning Tote Tasmania. The broker thinks consolidation is creating a more rational environment. This year has seen a number of high profile transactions completed in the wagering market, driven by UK operators William Hill and Ladbrokes.

Regarding the UK, there are draft changes to online gaming tax which will, in CIMB's view, have significant implications for Australian online wagering, by further attracting sophisticated new entrants and permanently changing the industry structure. These new entrants operate on significantly lower win margins compared with incumbents. They also offer more products on sophisticated platforms. As a result, the broker believes the market is not correctly pricing this risk for Tabcorp and Tatts. This underscores CIMB's Underperform call on the stocks and Underweight stance on the sector. The key point from the UK government's draft online gaming bill is the proposed "point of consumption" 15% gross profit tax on UK-based revenue from December 2014. This closes a loophole in the UK that allowed most gaming companies to avoid tax as UK customers were technically betting offshore. This implies a significant loss of earnings for the major UK online bookmakers, particularly for Betfair.

CIMB suspects that Betfair may want to increase its offering in the Australian market, particularly given the new CEO's expertise in the Australian online wagering segment. A rejuvenated Betfair Australia would further intensify the competitive environment in online. Indeed, the UK companies have responded to the tax plans with offshore expansion into large regulated markets such as Spain, Italy and Australia. CIMB thinks, given its betting culture, relatively young online market and competitive structure, that Australia is the most attractive option. Hence, the recent arrival of William Hill, through the acquisition of Sportingbet and Tom Waterhouse, and Ladbrokes, via the acquisition of Gaming Intelligence. They join Paddy Power which entered the market in 2009 via Sportsbet.
 

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article 3 months old

Weekly Broker Wrap: Aust Healthcare, Building, Retail, Gaming And Transport

-Solid defensives in Aust healthcare
-Conflicting stories in building
-Discretionary retail trends diverge
-Aust gaming subdued
-Transport dividends up

 

By Eva Brocklehurst

Australia's healthcare sector retains some attractive defensive characteristics but the valuations are not generally defensive, in Morgan Stanley's view. ResMed ((RMD)) holds the most upside potential for the broker. Sonic Healthcare ((SHL)) was upgraded to Overweight during August, joining ResMed, Primary Health Care ((PRY)) and Sigma Pharmaceuticals ((SIP)) in the category.

Morgan Stanley had been concerned that Sonic would miss expectations as a result of fee cuts across major geographies and a benign US volume environment. FY13 results surprised, however, and this provides a higher forecasting base. The broker understands that execution of the US cost cutting program is now complete and benefits are expected in FY14. This cost cutting may negate most known fee cuts in FY14 and provide the platform for growth which the broker was previously skeptical about. Sonic is considered a defensive volume growth story.

US device growth at 16% in FY13 was in line with expectations and ResMed benefitted from the shifting of the mix as home sleep testing accounts for a greater proportion of prescriptions. Mask sales growth in the US was over 8% in the second quarter but ResMed lost share. The broker expects new releases will claw back this lost share and revenue could surprise on the upside if the new devices gain traction. Home Sleep testing now accounts for over 30% of US volumes and is expected to approach 40% over the next year. The competitive bidding pricing is already known for the bulk of round two contract winners and this leaves ResMed with good forward visibility and confidence in the outlook.

Building materials stocks have seen price/earnings re-rating that was ahead of results, in anticipation of a growth recovery. Morgan Stanley thinks FY14 will provide some growth but for the most part consensus expectations are seen as still too high for the broker's liking. The most preferred stock is DuluxGroup ((DLX)), a high quality company generating a high return which justifies its P/E premium, in Morgan Stanley's opinion. Dulux has more defensive earnings characteristics than other building materials stocks, but still offers solid growth prospects. Earnings upside may come from a sharp fall in the titanium dioxide price, which is a significant input cost to paint. Working capital opportunities in the former Alesco businesses could drive further upside.

The broker's least preferred stocks are Fletcher Building ((FBU)) and CSR ((CSR)). Fletcher is exposed to a recovery in the New Zealand housing market, where it is the leading player through its vertical offering. This is the main positive. There is no FY14 guidance, and consensus expectations for FY14 and FY15 appear aggressive to Morgan Stanley. Revenue looks light across most of the divisions. No significant volume growth is expected in Australia while North America remains mixed - positive on the residential but flat on the commercial side.

CSR is positioned for a recovery in the Australian residential market but the broker sees challenges within aluminum and the Viridian turnaround requires proof. CSR offers some of the best exposure to an improving east coast property market but it's not enough to change an Underweight recommendation. Strength in building products is offset by execution risk in Viridian and risks around the aluminium assets.

JP Morgan has taken a look at the US operations of Boral ((BLD)) and James Hardie ((JHX)). Boral's performance through the downturn has mirrored that of the broader construction industry, i.e. spiralling losses, followed by deep capacity cuts and restructuring efforts. The future of the US business hinges on a number of factors, in the broker's opinion, principal among these being a recovery in brick intensity.

In contrast, James Hardie's performance through the downturn has been exceptional as it is one of the few building-related entities in the US to remain comfortably profitable. In fibre cement James Hardie stands out with a differentiated product and high market share. Boral has been affected by the volatility that is typical of fragmented industries such as bricks and tiles. In terms of pricing,  brick and tile that was resilient, although future increases will need to be considerable to restore returns, in JP Morgan's view. Again, in contrast, James Hardie has battled on the price front.

Australian retailers had a stronger second half of FY13 with earnings up 4% relative to the 3% lift in the first half. UBS finds household goods in terms of JB Hi-Fi ((JBH)) and supermarkets in terms of Woolworths ((WOW)) reported the strongest results. Billabong ((BBG)) and Pacific Brands ((PBG)) were notably soft.

For the staples, reactions were mixed while results were in line. Whereas Wesfarmers ((WES)) fell as the softer second half for Coles was construed negatively, despite Wesfarmers announcing a capital return, Woolworths ((WOW)) performed strongly, as the market reacted to the upbeat commentary on FY14 momentum. UBS views the grocery sector as fair value, but thinks Woolworths has the greatest scope to outperform. The third player, Metcash ((MTS)) sustained 5-10% downgrades in the wake of its AGM, as IGA sales were reported to be hit by heightened levels of fuel discounts by the major chains.

In discretionary retailing the trends parted. Household goods, underpinned by improving house prices, performed well while the department store/fashion area was soft. Looking forward, UBS expects this trend to continue, with increased competition in fashion to present a risk to department store forecasts and an improving housing backdrop to provide upside to those stocks such as Harvey Norman ((HVN)) and JB Hi-Fi.

Crown ((CWN)) and Aristocrat ((ALL)) remain Deutsche Bank's favoured stocks in the gaming sector. Australian gambling expenditure is expected to remain subdued through the remainder of 2013. Crown will benefit from its exposure to the higher growth Macau and Perth markets and has introduced some cost reduction initiatives in order to offset the weaker trends at Crown Melbourne. Aristocrat is sustained by the fact it generates just 27% of earnings from Australia. Of note to the broker, Crown and Tabcorp ((TAH)) were unusually quiet about trading in July and August. Echo Entertainment ((EGP)) and Tatts ((TTS)) reported positive trends. Echo was boosted by strong growth in the VIP segment while Tatts benefited from a favourable jackpotting sequence in lotteries.

The weakness previously seen in gaming machine expenditure has also affected gaming tables, and there's been a softening in wagering and keno expenditure. Conversely, lotteries expenditure has remained buoyant, although Deutsche Bank thinks this can largely be explained by the favourable jackpotting sequence. In order to offset the weaker than anticipated top line growth, some of the companies introduced cost reduction initiatives and there is an increased focus on cost control and margin improvement.

Transport produced three main themes from the earnings season. In Deutsche Bank's view, these are cost reductions, higher dividends and an uncertain outlook. Most results were in line with forecasts. Qantas ((QAN)) showed the largest variance because of an accounting adjustment to the treatment of ticket revenue. Dividends were generally higher, with Aurizon ((AZJ)) standing out. Asciano ((AIO)), Royal Wolf ((RWH)) and Toll Holdings ((TOL)) all delivered better-than-expected dividends. The changes to FY14 earnings expectations were mostly small, with the airlines being the largest downgrades on the back of fuel and capacity/yield pressures.

Deutsche Bank now has three Buy recommendations in the large cap transport space, these being Asciano, Aurizon and Toll. Toll is being more disciplined on costs and strategy but has less earnings visibility than the other two. Brambles ((BXB)) is no longer a top pick and was downgraded to Hold from Buy during the earnings season.
 

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article 3 months old

Weekly Broker Wrap: Worries Grip Brokers As Earnings Season Ramps Up

-Life insurance problems hard to fix
-Squeeze on Oz industry with gas shortage
-Which are the best Oz super consumer stocks?
-Which are the worst?
-Low rates not all that good for banks
 

By Eva Brocklehurst

There's no quick-fix solutions to life insurance. JP Morgan believes it may take time to restore profitability in the life insurance industry. Hence, volatility will reign. The broker notes sharp earnings declines for many risk insurers, citing AMP ((AMP)), where operating margins have fallen to 6% in the first half from 20% of premiums in 2009, while growth in premiums stayed strong. Four issues are highlighted. These include increased lapses which triggered write-downs in capitalised up-front commission and other costs earlier than expected, a worsening claims experience in disability income because of greater incidence and longer duration, aggressive group insurance prices and, lastly, late reporting and deterioration in trends in group total permanent disability claims.

Guaranteed renewability of life insurance polices and high capitalised up-front commission make life insurers prone to difficulties, in the broker's view. There is more competition in insurance than other financial markets and the industry used to benefit from mortality improvements to offset. This benefit has slowed materially. JP Morgan notes industry lapse rates appear to have been deteriorating since 2008, in part from aggressive new business pricing, a more price savvy consumer and planner practices that churn more business. Solutions? Short term this rests with customer retention initiatives and price increases. Longer term the fixes may come from industry agreements on changing planner remuneration on new business. Either way, inroads into the problems will not be made quickly.

Construction and industry will face the first squeeze when it comes to gas supply shortage on the eastern seaboard. East coast gas demand is set to triple in the next three years, driven by the start-up of three LNG developments in Gladstone, Queensland. During the initial years these projects will be short of gas and, having had billions of dollars sunk into development, they are highly incentivised to buy additional volumes to maximise utilisation. BA-Merrill Lynch believes this situation will result in a price shock. The broker believes that, with LNG currently selling at around $14/gigajoule, and short run marginal costs of an LNG development at less than $4/GJ, the LNG projects can afford to pay over $10/GJ during ramp up. While that level of pricing may be short lived the impact on commercial and industrial users should not be understated.

Merrills thinks there are negative implications for a hike in gas prices across domestic building materials and chemicals, where the ability to pass through costs is limited. Companies flagged on this basis include Incitec Pivot ((IPL)), Orica ((ORI)), CSR ((CSR)) and Adelaide Brighton ((ABC)). In terms of gas utilities, Origin ((ORG)) is the broker's preferred stock in light of the potential tightness for gas. Legacy and equity gas positions, with limited exposure to price rises, are sufficient to underpin around 60% of the company's 160PJ/year requirement, even in 2020. In contrast, AGL Energy ((AGK)) has 50% covered, inclusive of its undeveloped Gloucester project, so the position is relatively weaker, although around 40% of sales are low margin commercial and industrial customers.

UBS is worried about FY14 for building materials companies. Trend growth in approvals is yet to translate into sales. Boral ((BLD)) offers leverage to a falling Australian dollar and improving housing in Australia as well as growth in the USA and remains the preferred stock. CSR has the same factors underpinning the broker's Buy rating. Strength in New Zealand should support Fletcher Building ((FBU)). The broker has tested for the accuracy of building material company earnings forecasts and found that analysts estimates were good for those that were growing steadily but poor when it came to turning points in earnings. The prior year's earnings remain the best indicator of future earnings, it seems. In detail, Boral and CSR earnings were the hardest to forecast and Adelaide Brighton the more accurate.

Merrills is worried about the Australian consumer. The outlook appears worse based on recent anecdotes. Nor is it just retail sales. A larger portion of household income is being spent on services and this broadly is crowding out discretionary retail spending from consumption. The gap between household income growth and the rise in the cost of living has narrowed significantly. As a result the broker sees stocks with exposure to the rising Chinese middle class as the way to play.

In what Merrills refers to as the consumer super sector - gaming, media, telcos, healthcare are included - the key performers are Crown ((CWN)), Treasury Wine Estates ((TWE)) and CSL ((CSL)). Crown will benefit from exposure to the gambling market in Macau. Chinese middle classes are a high margin market for wine. CSL? There is growing demand for health care in China and one third of the company's albumin sales are already derived from this country alone. Telstra ((TLS)) is seen as the defensive play. The company has minimal direct exposure to China but does own 74% of Hong Kong wireless operator, CSL New World. As consumer spending increases so too will travel and Hong Kong remains a key destination for mainland Chinese. Increased inbound roaming will boost mobile revenues for the likes of the Hong Kong telcos.

Merrills notes comments from McDonald's about Australia being a key area of weakness in the June quarter. So which stocks will suffer most in the consumer super sector? Merrills thinks Myer ((MYR)), Harvey Norman ((HVN)), Tabcorp ((TAH)) and Cochlear ((COH)). Retailers Myer and Harvey Norman are obvious examples of companies suffering from a cautious consumer, while Tabcorp's outlook is expected to be constrained by a tough competitive environment. Cochlear is engaged in a structural slowing, in Merrills' view, and needs to enter the clinic channel in developed markets at a lower return on equity and this has reduced the broker's confidence in value upside.

Westpac ((WBC)) capitulated on discounting heavily on new mortgages with its reduction to mortgage rates of 28 basis points, larger than the Reserve Bank's recent cut to the cash rate of 25bps. Credit Suisse believes the strategy to shore up market share by discounting only new mortgages failed anyway. The move by Westpac confirms to the broker that stemming entrenched market share losses through pricing requires both front and back book discounting, including perhaps tiered front book discounts to attract larger sized loans.

Credit Suisse observes that, while there are some clear benefits associated with lower cash rates such as accelerating the pace of credit growth and alleviating borrower solvency concerns, there is also a dark side for banks. Features of this include accelerated amortisation of lending portfolios through scope for higher mortgage prepayments, endowment margin compression with a lower rate earned on free funds and the temptation for banks to practise extensive loan forbearance. In terms of the latter, Credit Suisse senses that the lessons of the early 1990s might have been somewhat over-learned by the major banks, with at-the-margin banks showing too much forbearance on existing impaired assets. The broker refers to a Bank of England study that suggests that, by suppressing corporate default rates, forbearance might also contribute to an under pricing of risk in financial markets.
 

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article 3 months old

Constrained Outlook For Gaming

-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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article 3 months old

Echo Ups The Ante

- Echo counters Crown's Barangaroo proposal
- Brokers impressed with scope
- Return potential under question


By Greg Peel

Echo Entertainment ((EGP)) has found itself caught between a rock and a hard place. Echo is the operator of Sydney’s only casino, The Star, located on the Pyrmont side of Darling Harbour. Now that construction is underway of the massive Barangaroo development on the Walsh Bay side of Darling Harbour, rival Crown ((CWN)) has lobbied the NSW government to build a casino and hotel establishment as part of the complex, with a focus on attracting VIP gamers – the so-called “high rollers”. Despite wide community protest, the government is very tempted by the idea.

If Echo remained on the sidelines, and the Crown proposal were to be approved, the risk is Crown’s casino would split the Sydney market and suck away Echo’s revenues. If Echo counterbids and offers to build the second casino itself, in an attempt to head off Crown, the second casino would still cannibalise the revenues of the first.

Echo has thus come up with what analysts feel is a very compelling counterbid for the government to consider.

Echo will spend $1.1bn to convert The Star from what now is arguably just an oversized RSL into an international resort and gaming complex, featuring 500 hotel rooms across two five and six-star hotels, luxury villas, 20 new restaurants/bars, a rooftop water park, and improved infrastructure in the Pyrmont precinct, funded by the company, including a pedestrian bridge crossing Darling Harbour from Barangaroo and additional public amenities.

Moreover, Echo will pay the government $250m for a 15-year extension of The Star’s exclusivity, including $100m upfront. It is a proposal that will surely have the government licking its lips. Barangaroo is the iconic site, being close to the CBD and other Sydney landmarks, while The Star is located on the cheaper side of Darling Harbour as a seeming extension of the tacky shopping mall adjoining the convention/exhibition centres, which are also supposed to be past their use-by dates. Yet Citi notes Echo’s plans fit the government’s tourism ambitions and drives infrastructure investment in the Pyrmont area. BA-Merrill Lynch suggests a hotel roll-out has strategic merit in the underpenetrated Sydney market. And what’s more, a casino already occupies the Pyrmont site, suggesting no community backlash would stem from The Star simply growing upward.

Echo has also offered the government a second option. Echo will go ahead and build its resort/casino complex at Pyrmont and concede a Barangaroo casino to Crown if Crown is restricted to building a VIP-only casino rather than a general gaming establishment competing directly with The Star. Under option two, there would be no $250m exclusivity payment.

Deutsche Bank sees the Echo proposal as “strategically astute”. Merrills believes it offers an impressive and competitive alternative to Crown and Citi believes it compelling and increases its chances of success. The problem is as to whether after spending $1.1bn to build the new Star, with another $250m paid out for exclusivity in option one, the returns will be there for Echo to justify the investment. Option two omits the $250m but may not sit well with Crown, and also loses Echo lucrative high roller business potential.

Merrills sees the scope for higher returns “to be challenged”. Citi notes the size of the exclusivity payment would limit valuation upside. Macquarie suggests there is very little clarity on the earnings uplift Echo could expect, and clearly the proposal anticipates a significant pick-up in visitor numbers on the back of better on-site attractions and improvements to local infrastructure.

There is general agreement that Echo’s balance sheet can handle the deal, although another $1bn spent on the Brisbane casino may push the debt limits and Merrills would not rule out an equity raising at some point. Macquarie believes Echo’s Sydney licence positions the company well to capture further growth and increasing returns on capital and that the property has corporate appeal. Both Macquarie and UBS believe the risks surrounding the Crown issue are already priced into Echo shares at current levels.

A period of uncertainty will now follow, as we await a government assessment of the proposal and a response from Crown.

Macquarie and UBS both retain Buy or equivalent ratings, while Deutsche Bank, Merrills and Citi are comfortable with Hold amongst the uncertainties. Other FNArena database brokers are yet to update their views, leaving a Buy/Hold/Sell ratio of 3/4/1 on a consensus target of $3.62.
 

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article 3 months old

Weekly Broker Wrap: Carbon Tax; Banks; Gaming Gambles

- Which stocks benefit from no carbon tax?
- Merrills sour on Oz economy and bad debts
- Fixed odds threaten tote operators
- Barangaroo battle tough for Echo
 

By Greg Peel

The Coalition has promised to repeal the carbon tax and it is assumed the Coalition will form the new government post the September election. Depending on the upper house result, the tax could be repealed quickly or may need to wait for a double-dissolution election in mid-2015, Citi surmises.

By all accounts, the introduction of the carbon tax has had little impact on the Australian economy to date, and the Coalition will have an even greater task in reining in the budget deficit if the tax is repealed. But, a politician’s promise is a promise.

Stop laughing.

Were the tax to be repealed, various sectors and stocks on the Australian market would benefit on a discounted cash flow basis. Citi has made some calculations and provided some indicative estimates of DCF gains.

Among the miners, copper and gold stocks won’t see much joy but Alumina ((AWC)) could see an 8% gain and 3% gains await for BHP Billiton ((BHP)), Rio Tinto ((RIO)), Atlas Iron ((AGO)), Whitehaven Coal ((WHC)) and Iluka Resources ((ILU)). Greater gains are estimated for Gindalbie Metals ((GBG)) and Yancoal ((YAL)).

Beach Energy ((BPT)) would be a 5% winner among the energy stocks with Woodside Petroleum ((WPL)) and Santos ((STO)) looking at 2%. Downstream, Origin Energy ((ORG)) will see a neutral impact while AGL Energy ((AGK)) should benefit although Loy Yang will lose its compensation.

There will be minimal benefits for developers & contractors but building materials stocks Adelaide Brighton ((ABC)), Boral ((BLD)) and CSR ((CSR)) should see 1-4% gains. Transport stocks may be the big winners, not Asciano ((AIO)) and Aurizon ((AZJ)) but Qantas ((QAN)) should see a positive profit impact of 15% and Virgin Australia ((VAH)) 27%.

There will be little impact on REITs but retailers should enjoy the benefits of consumers with more money to spend, assuming no other taxes are introduced instead.

The carbon tax may not have impacted on the Australian economy but that is not to say the Australian economy is in rude health at present. The transition from mining-driven to non-mining-driven is offering up a lag despite easy policy from the RBA. The now weaker currency will provide benefits but in the meantime BA-Merrill Lynch is expecting GDP growth to slow to below 2% in 2015-16 and unemployment to peak at 6.75% in 2016.

Credit demand has remained subdued since the GFC but the level of bad debts has been steadily falling as the immediate impact of the GFC fades. The banks made large bad debt provisions as a precaution in 2009 and since then earnings have been supplemented by being able to return provisions incrementally to the bottom line. But Merrill’s suggests bad debts will again rise in a weaker economy and more so were the economy actually to fall into recession, to which Merrills ascribes a 25% chance.

The analysts remained negative on the banking sector early last week despite share price falls. ANZ Bank ((ANZ)) remains the broker’s top pick amongst the banks given its exposure outside Australia. Bank share prices have fallen quite a deal further since.

Australian consumers may still be holding back post-GFC but they are having no trouble throwing their money away instead, as the recent Waterhousegate controversy has highlighted. The rise of highly publicised internet-based betting at fixed odds is taking its toll on the traditional bastion of wagering on the tote. CIMB estimates fixed odd betting’s share of wagering revenue will reach 24% in FY13, up from 11% in FY10.

Alongside the familiar betting shop names now prevalent, highly sophisticated UK players have now entered the market. CIMB sees fixed odds as commanding 34% market share by FY16 and 43% by FY19. Fixed odd bookies operate on win margins of around 12% while tote margins average 18-19%. Not only will the totes be losing market share on the growth of fixed odds, their win margins will be under pressure as well.

CIBM has Underperform ratings on both Tabcorp ((TAH)) and Tatts ((TTS)).

At the higher end of town, beyond the Red Hots, Dish-Lickers and Footy, is the high roller casino planned for Barangaroo in Sydney. James Packer is lobbying hard for his Crown ((CWN)) to build a hotel and VIP casino on the site and is willing to commit $1bn.

Crown’s plans put rival Echo Entertainment ((EGP)) in a difficult position, notes Citi. As operator of the existing Star Casino across the water at Darling Harbour, Echo’s earnings would be threatened by the competition of a Crown operation nearby. To block Crown, Echo would need to counterbid which means also committing at least $1bn. And if Echo were to win the bid, and build another Sydney Casino, Citi estimates up to $52m of earnings lost in the first year due to cannibalisation.

Citi believes Echo has sufficient balance sheet capacity to complete its major development in Brisbane and in Sydney if it came to that, but despite strong cashflow and a relatively attractive valuation, Sydney uncertainty means Echo only attracts a Neutral rating from Citi. Crown’s Macau exposure underpins an Outperform rating.

In late news, Echo has approached the NSW government with two options, one involving Echo winning the bid and the other conceding high rollers only to Crown.


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