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Morningstar | Improvement in Adelaide and Solid VIP Turnover Support SkyCity’s Strong Fiscal 2018 Result

Narrow-moat-rated SkyCity Entertainment reported a solid fiscal 2018 result. Normalised EBITDA increased by 6% to NZD 338 million, around 2% above our expectations, owing to the surprise improvement in Adelaide and stronger-than-expected international business turnover. Normalised net profit increased by 10% to NZD 170 million, exceeding our projection by 4%, mainly due to lower depreciation expense. We retain our NZD 4.20 fair value estimate (AUD 3.80 at the current spot price), and shares are fairly valued at the current levels. The board declared a final dividend of NZD 0.10 per share (fully imputed for New Zealand tax residents), taking the total for the year to NZD 0.20 per share, consistent with the current policy.

The core Auckland business, which contributes the majority of SkyCity's earnings, had another steady year, with revenue growing by 3% to NZD 531 million, supported by strong hotel occupancy, strong visitation at Sky Tower, and a strong second half for gaming machines. EBITDA margin expanded slightly, which we attribute to operating leverage. We still expect steady performance in Auckland, as the major drawcard in the city, including the construction of the conference centre. As the main contributor of group earnings, Auckland will remain the key driver of valuation for the foreseeable future.

Management did not provide explicit earnings guidance, although it expects modest growth in normalised group EBITDA for fiscal 2019. We project the New Zealand properties to continue growing at a low-single-digit pace for the near term. However, we forecast a material earnings uplift from fiscal 2020 when the NZICC opens, supporting high-single-digit EBITDA growth at Auckland, on average, during the next five years.

The Adelaide casino performed surprisingly well, and while revenue was flat, EBITDA grew by almost 13%, albeit off a low base, to AUD 23 million, despite the ongoing disruption at the Riverbank precinct. The main driver of this improvement was effective cost management and stronger premium gaming. This is particularly pleasing given that Adelaide’s earnings have struggled for the past six years. Nonetheless, we believe the Australian businesses will continue to struggle in the near term, and earnings growth will likely be constrained to the low-single-digit range. The longer-term prospects, however, are more positive. We expect SkyCity's major development in Adelaide to see a step-up in earnings from fiscal 2021, when the project is fully ramped up. We forecast an EBITDA uplift of around 13% per year on average, during the four years following the major reinvestment.

International VIP business is likely to remain another growth driver in the coming years. Turnover jumped by almost 40% in fiscal 2018, almost reaching fiscal 2016 levels, prior to the arrest of several Crown employees. We had previously expected turnover to return to NZD 12 billion within the coming years, but this occurred sooner than expected. We still believe this is a very low base and see considerable headroom for growth. Given the ongoing major reinvestment program, and New Zealand's proximity to Australia and attractiveness as a tourist destination, SkyCity is well placed to capitalise on growing VIP volumes in the region, especially from Chinese high rollers. This should support high-single-digit international VIP turnover growth for at least the next five years. We had expected margins to come under some pressure due to the additional reliance on junkets and associated commission payments. However, this was more than offset by natural operating leverage within the international VIP business, driving EBITDA growth of over 70%.