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Morningstar | Record High VIP Turnover Drives Star’s Stellar Fiscal 2018; FVE Lifted to AUD 4.80 per Share

Record high VIP turnover drove an impressive fiscal 2018 result for no-moat-rated Star Entertainment. The company reported normalised net profit after tax of AUD 258 million, up 20%, although this was consistent with our forecasts. The board declared a final dividend of AUD 13.0 cents per share, taking the full year total to AUD 20.5 cents per share (fully franked), a 28% increase on the prior year. This translates to 67% of underlying EPS, slightly ahead of our expectations.

We’ve lifted our fair value estimate by 9% to AUD 4.80 per share to reflect: (1) a stronger VIP outlook; (2) improving main-floor gaming in Sydney; and (3) revenue uplift at the Gold Coast as it reaps the benefits of recent expansion and refurbishment projects, each of which contribute to an average 5% increase in our earnings projections over the next five years. Management also indicated that capital expenditure peaked during fiscal 2018 and will decline from fiscal 2019 onwards. At current levels, the stock is slightly overvalued relative to our fair value estimate, with the downside driven by likely medium-term earnings pressure upon Crown Sydney’s opening in 2021. However, over the long term we expect this earnings hole to be partially plugged upon completion of the Queens Wharf and Gold Coast developments a couple of years later.

The recovery in VIP was the main driver of earnings growth, with Sydney turnover up over 55% on the prior year to AUD 52 billion, and now ahead of rival Crown. Whilst we had predicted a gradual recovery in VIP turnover, the timing beat our expectations, and has now exceeded the highs set prior to the Crown arrests in 2016, and for the first time in Star’s history above AUD 50 billion. The rebound did come a slightly higher cost, with taxes, levies, rebates, and commissions up 21% on the prior period. However, this reflects increased reliance on junkets and additional staff incentives, both of which were necessary to attract VIP customers and ultimately drive the recovery. We expect that as turnover stabilises, these additional costs will moderate in the coming years. Notwithstanding, group EBITDA margin held steady at around 22%, and should improve by a modest 100 basis points in the coming years on the back of ongoing cost-cutting and operating leverage.

We expect the strong momentum in domestic gaming revenue to continue, growing at a mid-single-digit pace in the near term. This will be driven by continued market share gains in the slot machine market and mean reversion of hold rates, which at 18% (during fiscal 2018) are below long-term averages. Premium mass is also likely to perform better than previously expected, despite the ongoing refurbishment of the Sovereign room and temporary relocation of these facilities. While it is still early days, management indicated the initial customer feedback on the temporary facilities has been positive, with easier access to carparks cited as a major improvement. Notwithstanding, we still expect Star’s premium business to suffer upon Crown Sydney’s opening, which we expect will make a 20% dent in domestic table revenue by the time the rival facility ramps up in fiscal 2022.

Queensland is home to company’s most exciting growth prospects. The Queen’s Wharf project in Brisbane is tracking according to plan and expected to come on line in fiscal 2023. Concurrently, the firm will build its first joint-venture tower in the Gold Coast, which is expected to add 700 rooms, essentially doubling the current capacity. Star is a one-third partner in the development, and while the earnings contribution from the hotel itself is likely to be modest, the benefit of additional foot traffic into the Gold Coast casino will be retained by the company. The firm is progressing with its multiyear master plan, which as previously flagged could include up to five mixed-use joint-venture towers, although the timing, cost, and size of these are unclear at this stage, and not factored into our current projections.

Star’s balance sheet health improved during fiscal 2018, evidenced by net debt declining to 1.2 times EBITDA from 1.8. This was a function of exceptional 105% cash conversion (although this reflected the timing of movements in working capital, and should revert to around 100% on average), as well as the AUD 490 million equity placement undertaken in the second half, partially offset by peak capital expenditure. Management indicated capital expenditure is likely to fall to between AUD 300 million-AUD 350 million (inclusive of the Sydney Sovereign Resort upgrade) in fiscal 2019 and 2020, down from AUD 477 in fiscal 2018, in part driven by a more favourable contract outcome for the first joint-venture tower at the Gold Coast. Accordingly, we expect net debt to fall to around 1.0 times EBITDA within the next three years. The firm should have no issues sustaining a 70% dividend payout ratio for the foreseeable future.