Three years after initiating a restructuring that promised better results by rationalising costs and optimising its properties, casino and hotel operator Sun International has picked the low hanging fruit and is now facing headwinds.
“Our real problem is the core SA gaming business and this is affected by the economy in South Africa,” says Sun International CEO Graeme Stephens. “But it goes beyond that – there is a feel-good factor that is missing. People lack confidence at the moment, and when you lack confidence you don’t spend your money in a casino.”
Regulatory woes are not helping. Last December the Competition Commission blocked the acquisition of Peermont Global, which Sun was acquiring partly for the attractive Emperor’s Palace Casino but also because Peermont had agreed to shush its objections to Sun’s plan to move its under-exploited Morula Sun Hotel and Casino license to Menlyn Maine.
Prior to that the competition authority scotched a complicated plan that would see competitor Tsogo Sun acquire a 40% stake in GrandWest and the smaller Worcester casino. With that deal off the table the Western Cape government may yet allocate a second casino license in Cape Town, which is a problem for Sun. “We need to find a solution. Ourselves and Tsogo and Grand Parade,” says Stephens. “The environment is open to dialogue.”
Increased pressure from electronic bingo terminals is adding to pressure on the bottom line. This can be seen in the Eastern Cape in particular. “Earnings at the Boardwalk in Port Elizabeth have fallen from R86 million to R66 million and that is not only the poor economy,” says Stephens. “EBT licenses are being issued to our detriment and, we believe, in contravention of the license agreement.”
Despite these challenges, at the top line revenue increased by a respectable 10.3% to R5.8 billion for the six months. This was thanks to insourcing of the food and beverage operations, which saw the division contribute more revenue to the group than hotel rooms. In addition Monticello in Chile grew its revenues by 16.4% when translated into rands, offsetting negligible growth in South Africa where the core casino revenue was up by only 0.6% due to the weak economic environment.
Earnings before interest, tax, depreciation and amortisation (ebitda) were down marginally (0.8%) at R1.6 billion. As a result of the disappointing South African casino revenue growth and the addition of the new, low margin food and beverage business, the overall group ebitda margin declined 3.0% to 27.4%.
Adjusted headline earnings of R346 million and diluted adjusted headline earnings per share of 332 cents were 19% below last year, while dividends per share decreased by 18%.
“What went wrong?” says Anthony Rocchi, portfolio manager at Rexsolom Invest. “Firstly, despite Sun International’s efforts to diversify its portfolio the ’80/20 rule’ applies, with the four biggest casinos (GrandWest, Sibaya, Carnival City and Monticello) contributing 90% of group earnings before interest tax (ebit). The ‘big four’ had a difficult year and on a like-for-like and constant currency basis this cluster saw ebit contract by 1.6%,” he says. The ZAR weakness and the increased stake in Monticello boosted ebit by 7% for this cluster.
However the big charge that helped the group record a loss before tax relates to the failed acquisition of the Peermont Group, says Rocchi. “Peermont, which was the chief opponent to Sun relocating its Morula Casino to the suburb of Menlyn because of its proximity to Emperor’s Palace, withdrew its objection in the anticipation of a successful acquisition (by Sun). However when this failed, a settlement became payable.”
The failure of the deal will trigger an obligation to pay Peermont an amount between R700 million and R900 million. The parties have settled on R675 million. Sun has also paid R72 million to a smaller slots operator which had also objected to the casino’s move.
On the positive side, work on the new Menlyn casino is moving ahead swiftly and the group plans to invest R4 billion in the project in the coming year. The casino will open in 2017. This investment will push debt levels up to a heady 3.5x ebitda, which Stephens acknowledges is somewhat high. “We would be more comfortable with 3x,” he says.
Latin America’s share of group revenue increased with the strong growth in Monticello’s revenue and a full period of trading at the Ocean Sun Casino in Panama and the Sun Nao Casino in Colombia.
Latam will continue to grow relative to the rest of the business and post the merger with Dreams (before year end 2016) is anticipated to contribute around 30-35% of group revenue. The Dreams merger will diversify the earnings base of the group and brings a number of expansion opportunities which will be considered in due course, Stephens says.
The stock is down a whopping 47% from a year ago and is trading at a 25% discount to Rexsolom’s estimated fair value (R95). This may also be indicative of higher taxes in store for the gaming sector to be announced during the budget speech.
Alternatively the price may be indicative of a broader trend in the gaming industry. “Take a look at the share prices of MGM Resorts, Las Vegas Sands or Caesars Entertainment,” says Reuben Beelders, CIO at Gryphon Asset Management. “None of them are shooting the lights out. Why is it that in a depressed consumer environment a company like Truworths can continue to return double-digit growth? Is there is something more fundamental happening? My sense is that casino revenue is falling around the world.”
Stephens is more upbeat, however: “Through the improved performance of the new properties, new lines of business, insourcing of food and beverage and a continued focus on cost savings and efficiencies we anticipate growth in both revenue and ebitda in the second half of the financial year.”
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