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Morningstar | Tabcorp’s Strong Lottery Performance Offsets Challenging Wagering Environment. See Updated Analyst Note from 12 Feb 2019

Narrow-moat Tabcorp reported an interim 2019 underlying NPAT of AUD 211 million, more than double the previous corresponding period. This rapid growth mainly reflected a full six-month contribution from recently acquired Tatts. Had the Tatts acquisition been in place for the full comparable period, revenue and EBITDA would’ve increased by 6% and 9%, respectively, a more modest, but positive result, nonetheless. Lotteries was the standout performer during the period, reflecting strong digital growth and new game initiatives, boosted by a favourable jackpot sequence. Additionally, management flagged a higher cost savings target, as the merger integration with Tatts is progressing better than expected. The board declared an interim dividend of AUD 11 cents per share, fully franked, in line with our forecasts. Our AUD 4.50 per share fair value estimate is unchanged, as the stronger performance in lotteries, and additional cost synergies are offset by a more challenging wagering outlook. At the current price the shares are fairly valued.

Lotteries grew revenue by a staggering 20% on a pro forma basis, exceeding our expectations. Some of the strength in lottery is sustainable, and attributable to increased investment into game offerings and digital. However, we believe the majority was driven by a more favourable jackpot sequence, with an unprecedented six jackpots at or above AUD 50 million during the half. We are reluctant to extrapolate this growth, and remind investors of fiscal 2017 when Tatts was faced with an unfavourable jackpot sequence which negatively impacted performance. Accordingly, we have increased our fiscal 2019 lottery revenue forecast to capture the near-term uplift, although our long-term revenue growth forecasts are lifted slightly by around 1% on average over the next five years to 6%, reflecting structural improvements. Lotteries and Keno now represent around half group earnings, and remain the firm’s most attractive and defensive businesses.

Offsetting the strength in lotteries was a softer than expected result from the wagering division. Turnover growth of 2% was broadly in line with our expectations, as digital turnover continues to grow at a low-double-digit percentage rate, at the expense of traditional brick-and-mortar wagering. Digital presently accounts for just over 40% of wagering turnover and, on our expectations, will surpass retail channel wagering in size within the next three years. However, overall wagering revenue declined by 3%, falling short of our projections. This reflects an increase in generosities (rebates and incentives) and lower fixed odds yields, which was driven by operators in the industry aggressively pursuing market share ahead of the introduction of wagering point of consumption taxes. These initiatives are required to entice and retain customers amid tough competition, and accordingly, we have lowered our wagering revenue growth forecasts to fall slightly in fiscal 2019 and grow by 3% per year on average during the next five years.

The firm’s main priority at present is the integration of Tatts, which at this stage is progressing better than expected. The company is tracking towards AUD 55 million synergy benefit for fiscal 2019, compared with the previously expected AUD 50 million. Additionally, management raised the synergy target to between AUD 130 million and AUD 145 million annualised EBITDA by fiscal 2021. This compares with previous guidance, and our prior estimates, of AUD 130 million per year, and mainly comes on the cost side where the long-term target is raised by AUD 15 million to AUD 95 million. We believe these synergies are achievable, given the high level of duplication between the two businesses and, as such, have lifted our synergy expectations to AUD 145 million by fiscal 2021.