EUR 850.00 For Business Accounts Only

Morningstar | Tabcorp Shares Fairly Valued but Offer Investors a Healthy Dividend Yield

Despite trading roughly in line with our AUD 4.50 per share fair value estimate, wagering and lottery giant Tabcorp offers investors a very attractive dividend stream. At the current price, the stock yields a reliable 5% (fully franked), which is impressive, especially given the current low interest rate environment. We think the company can sustain a payout ratio of about 100%, supported by: (1) a highly cash-generating lotteries business, (2) the integration of the acquired wagering businesses, which is already generating cost savings and (3) the healthy and rapidly deleveraging balance sheet. We’ve trimmed our near-term EBIT forecasts by about 2% average, on the back of softer wagering yields, investment into digital, and less favourable terms on renewing gaming services contracts. Notwithstanding, our long-term view, valuation and narrow moat rating are all unchanged.

Fiscal 2019 is shaping up to be an exceptionally strong year for the lottery and keno division, which makes up about half of group EBIT. This performance is supported by an unusually high number of jackpots at or above AUD 50 million, 11 in the current fiscal year to date, compared an average of about four per year during the past three years. Bigger and more frequent jackpots attract new customers, ultimately driving our 15% lotteries revenue growth forecast for the year. However, this phenomenon cannot be extrapolated in future, and we believe 5% growth per year is a more sustainable pace.

In the same way as most other gambling channels, lotteries are being digitalised at a rapid pace. At the current growth rate, flows from digital channels could reach as much as 40% of lottery turnover by fiscal 2023, compared with the current 22%. We therefore are likely to see the firm continuing to invest heavily in the digital experience, platform, and digital marketing. This additional operational expenditure will limit near-term margin upside, although longer term we see lottery EBIT margins expanding by about 150 basis points from current levels to a sustainable 15.5% by fiscal 2023, following increasing operating leverage and scale.

On the wagering side, the merger with Tatts has resulted in the firm achieving a market share of almost 60%. Currently the core priorities are transitioning UBET to the flagship TAB brand, cutting costs, increasing product innovation, investment into digital, along with maintaining and subsequently growing the customer base. Over the longer term we expect an improvement in the fixed-odds yield. However, in the short- to medium term fixed-odds net yield is likely to remain slightly lower, currently about 13.5%, 1% below the historic average. The lower yield reflects the ongoing investment into generosities, which should also help grow and maintain market share. The firm is also undertaking additional investment in advertising and promotions, data and digital capabilities, the retail experience and compliance. These costs, in addition to the lower yields are likely to cap any improvement in the wagering margin in the near term. We expect wagering margins to improve by about 300 basis points from current levels, to 21.5% in fiscal 2021, when the Tatts integration nears completion and the full run rate of synergies is achieved.

Despite the slightly elevated near-term capital expenditure (as the integration progresses) the firm’s balance sheet will remain in healthy shape, allowing the firm to pay out about 100% of underlying earnings. We estimate gross debt of about 3 times fiscal 2019 EBITDA, which is at the lower-end of the firm’s target range. Further, the highly cash-generating lotteries business, and cost synergies particularly in wagering, should help the balance sheet deleverage quickly, with debt/EBITDA falling to about 2.3 times by fiscal 2021.