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Morningstar | Soft VIP Turnover Does Not Impact our Positive View on Crown Resorts

Narrow-moat-rated Crown Resorts’ normalised net profit after tax grew by an underwhelming 1% to AUD 194 million, during first-half fiscal 2019. NPAT benefited from an AUD 10 million decline in depreciation, along with an AUD 19 million decline in net interest expense (reflecting reduced debt and higher capitalised interest associated with the Sydney project). Group normalised EBITDA declined by 7% to AUD 419 million, with the softness mainly reflecting a surprisingly sharp drop in VIP turnover during November and December, along with softer main-floor gaming, and higher labour costs. The board declared an interim dividend of AUD 30 cents per share (60% franked), and as per the recently introduced policy, we continue to expect the firm to pay out another AUD 30 cents per share in the second half.

We’ve cut our fiscal 2019 NPAT forecast by 8% to AUD 388 million, to capture the challenging near-term outlook, however, many of the challenges faced by the company are cyclical in nature. VIP which weighed on revenue is notoriously volatile, and we are reluctant to extrapolate two months of poor performance. Additionally, we attribute the reduced average spend per customer (and consequential soft main-floor gaming revenue) to softening consumer environment, and negative wealth effect resulting from declining residential property prices, both of which we expect to eventually stabilise. Accordingly, our long-term assumptions are broadly unchanged, and we maintain our AUD 15.00 per share fair value estimate. We project 6% EPS growth on average during the next three years, prior to the opening of Crown Sydney (for almost 20% of our valuation) which in our view is underappreciated by the market.

The performance was mixed at the Melbourne property (which represents around 75% of group earnings) where revenue and EBITDA fell by 1% and 3%, respectively. Mainfloor gaming grew by 2%, which is in line with our expectations, although (within the segment) gaming machines continue to disappoint, growing revenue by 1%, whereas table games were stronger growing at a healthy 3%. During the period, Melbourne’s visitation numbers were positive, although the average spend per customer was lower than recent years, which weighed on total turnover. We do not see any structural reason for this softness, and we continue to forecast main floor gaming should grow at around 4% per year over the long run. Melbourne’s operating margin came under some pressure, declining by 70 basis points to just over 28%, which reflected higher labour costs, and operating deleverage. We project margins to improve modestly, returning to 29% by fiscal 2021 though operating leverage (on the back of recovering revenue growth) and ongoing tight cost control.

VIP was the main source of pain during the period, with both Australian resorts underperforming and falling short of our expectations. Turnover fell by 12% to AUD 20 billion during the half, despite management flagging turnover at the Australian resorts rose by 13% during the first four months of fiscal 2019, implying an extremely weak November and December trading period. The reversal of the strong start to the fiscal year highlights exactly how volatile this segment is, with a small number of players able to significantly move the dial. The VIP business saw a similar number of players visiting the property, and strong booking numbers, although the average spend was lower, which we attribute to slowing Chinese economic growth, and tighter junket liquidity. Notwithstanding, Australia’s share of the global VIP market is currently negligible, and with the new Sydney casino likely to attract players to the region, we forecast Australia’s share to increase by around 200 basis points to approximately 6% over the long run.

The construction of the Sydney facility is progressing on schedule and remains on track for completion in the first half of calendar 2021. Management reiterated the total gross project cost of AUD 2.2 billion (AUD 1.4 billion net of apartment sales) and confirmed the apartment sales are progressing well especially as the building continues to take shape, largely unaffected by the recent litigation. The balance sheet is in pristine condition, currently operating in a net cash position. Moreover, we maintain our bullish outlook on Sydney, with a superior location and high-end focus, we forecast Crown to take just over half of Star Sydney's VIP market while concurrently growing the domestic market.

Perth remains a challenge, as revenue and EBITDA declined by 2% and 9%, respectively. The performance was weighed down by a 5% drop in table game revenue, and an almost-20% drop in VIP. Similar to Melbourne, Perth held good levels of visitation, however, the soft local economy saw players spending less in both the premium and mass tables. We don’t expect any major improvement in the near future, however, as the economy stabilises, we expect to see low to mid-single-digit EBITDA growth on average.