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Morningstar | Accelerated VIP Recovery Drives Crown’s Solid Fiscal 2018 Result; FVE Lifted by 7% to AUD 15.00

Crown Resorts’ fiscal 2018 normalised net profit after tax increased by 13% to AUD 387 million, in line with our AUD 383 million forecast. As expected, the recovery in VIP gaming at the Melbourne facility was the main growth driver, offsetting soft revenue from Perth and Aspinalls. We lift our fair value estimate for Crown by 7% to AUD 15 per share, reflecting an increase in our earnings forecasts. We’ve raised our EBIT estimates by around 4% on average during the next two years to reflect continued growth in VIP and improving outlook for main-floor gaming, both of which should offset the forgone earnings from recently-divested CrownBet. At the current price, the stock offers modest upside with a healthy dividend yield of around 4.5%, partially franked. Further, we see potential for additional share buybacks or special dividends in the future, as we believe the company will be significantly underleveraged upon completion of the Sydney casino project.

Crown Melbourne’s VIP turnover rebounded at a faster pace than we previously expected, increasing by over 70% to almost AUD 44 billion. We have adjusted our near-term forecasts, and now expect turnover to reach the previous AUD 52 billion high by the end of fiscal 2019. Despite growing rapidly during the past decade, Australia’s share of the global VIP market is negligible, and Crown should be able to continue growing its VIP business at a high-single-digit pace, on average, for at least the next five years.

Whilst the VIP business has high operating leverage, which should see margins expand with revenue, this was not the case due to less favourable mix shift. Melbourne’s EBITDA margin contracted by around 120 basis points to 28.3%, which reflected a shift in revenue towards lower-margin VIP gaming, and higher fixed costs including energy. Melbourne’s EBITDA margin should remain fairly steady over the coming years, with a continued shift towards lower-margin VIP business, offset by moderate operating leverage, lower energy prices, and cost cuts. We still expect 4% annual growth in Melbourne’s main floor gaming revenue. During fiscal 2018, table games revenue grew strongly at 5%, while gaming machines were flat, despite low-single-digit growth in the overall market. We expect gaming machine performance to improve in the near term as the company takes delivery of more of Aristocrat’s highly successful Link games.

Some weakness in the Western Australia economy is likely to continue weighing on Crown Perth’s main floor gaming in the near term. Fiscal 2018’s soft performance was no surprise, and Perth’s revenue declined by 3%, with main-floor tables and VIP hit the hardest. Perth’s EBITDA margins should remain at 30% on average, in line with current levels, with revenue growth constrained in the low- to mid-single-digit range.

The Sydney project is progressing well, and on track for completion in the first half of calendar 2021. Management reiterated total project cost of AUD 2.2 billion (AUD 1.4 billion net of apartment sales), although the capital expenditure timing has been pushed out slightly to reflect an updated timeline from the builder. We have assumed the new casino comes on line by the start of fiscal 2022, and takes approximately two to three years to ramp up, at which time we expect it to earn returns on capital north of 10% (comfortably exceeding the firm’s 8.5% cost of capital). Based on our estimates, by fiscal 2024 Sydney will generate around 20% of group EBITDA, roughly on par with Perth. We still believe Australian casino operators, and in particular Crown Resorts, should continue to benefit from growing inbound Chinese tourism. The Sydney property, targeting the premium and VIP market, and with its luxury hotels and high-end restaurants, is likely to appeal to the Chinese.

With a net cash position of around AUD 350 million as at year-end fiscal 2018, the company is undergeared, although we believe this defensive position is appropriate, given the heavy capital expenditure pipeline. Management also intends to undertake an on-market share buyback of approximately AUD 400 million, commencing in August 2018. If the buyback is undertaken at the current price, the implication for our valuation is negligible, as the shares are trading only marginally below our revised fair value estimate. We believe the company can undertake the buyback and fund the AUD 2.2 billion Sydney project without stressing the balance sheet. Even in the scenario where the company undertakes the buyback, net debt/EBITDA is likely to peak at around 1 times EBITDA during fiscal 2021, well within comfort levels, given the resilience of the company’s core earnings.