Macau's surge in business helping Packer Crown empire
Brokers took the opportunity to make some hefty upward revisions to the earnings outlook for casino operator Crown in the wake of the FY13 results, but it's a small enclave in China which was really the main catalyst. The Macau high roller segment growth accelerated to 18% year-on-year in June, the strongest in about a year and a half.
Australian consumer sentiment remains soft but the company is considered well positioned to improve the earnings of Australian casinos, given cost reduction initiatives at Crown Melbourne and the expansion of the main gaming floor at Crown Perth. Melco Crown, the joint venture in Macau in which Crown has a 33.7% interest, will enhance this earnings growth. Citi estimates the JV will represent 46% of group profit by FY15, from 22% in FY12. Domestically, earnings upside will also come from a new Crown Sydney development, potentially opening in late 2019.
Key concerns for brokers from this result were the weak gaming floor revenues in Melbourne, down 1.9% in the June half, although these did not translate to declining earnings as Crown effectively managed the cost base. It has further initiatives in place in FY14, although Citi is one broker which still expects margins to fall. Perth is improving but will also cycle a lot of one-off costs related to the re-launch and branding in FY13. Citi notes the consumer environment in Perth has the potential to slow materially given lower mining investment. Nevertheless, the Perth property is yet to realise benefits from additional car spaces, new gaming capacity, new hotel and cost optimisation.
Macquarie believes there's scope for further margin expansion from the cost base changes implemented in Melbourne as well as the transfer of cost efficiency lessons to Crown Perth, which has been re-branded from Burswood in September 2012. Macquarie is of the view this heightened efficiency should boost casino margins in Australia by 90 basis points in FY14. Crown continues to invest in its domestic facilities, which are currently acting as a drag on free cash flow. There have been some delays to the capex profile at Crown Towers Perth, which will now have the majority of spending booked in FY16. FY16 will be the peak period for capex as the completion of Crown Towers Perth coincides with the ramp-up of spending for Crown Sydney, in Macquarie's view.
Credit Suisse thinks it should be business as usual in Melbourne by FY15 and incremental revenue growth is expected to be driven by further VIP play, but Credit Suisse does not think margins will expand significantly as the VIP segment is generally a low margin business.
Crown's valuation is highly dependent on the Melco Crown JV share price. Citi has upgraded Crown's FY14 earnings forecasts by 11% and FY15 by 5%, mainly because of lower interest costs and Australian dollar forecasts. Despite this, following the recent strong share price run, Citi has decided to downgrade the rating to Neutral from Buy. Macquarie also finds the strong share price reaction after the result a dampener and, with limited returns from current levels, maintains a Neutral rating.
Credit Suisse went the other way and upgraded to Outperform from Neutral, incorporating a full valuation of Macau's Studio City into the model. Studio City is expected to open mid 2015 with 500 gaming tables, 1,500 slot machines and 1,600 hotel rooms. Today, Melco JV has a market capitalisation of US$14.5bn with essentially no net debt. The asset base is two casinos, plus expansion options. The broker suggests that the larger of the two casinos, City of Dreams, might be worth US$11bn, acknowledging the valuation seems generous given the risks of operating in an emerging market such as China.
Yet, if demand for gaming continues to grow in the region, Studio City has a similar capacity to City of Dreams and may be destined to be another US$1.0bn earnings casino. On that basis, using a cost of capital that probably understates the long-term history of business volatility in China, Credit Suisse thinks Studio City may reach a perceived value of US$7bn. Construction costs have been flagged at US$2.0bn. The broker's new valuation reflects a US$700m annuity stream from Studio City. Melco Crown will have 60-67% interest in Studio City.
One other item of interest to Credit Suisse, was the growth in Singapore. Singapore is a key competitor to Australia's VIP market and has been growing VIP volumes at both Marina Bay Sands and Resorts World, owned by Genting Singapore. In the most recent quarter both properties posted VIP volume growth in excess of 25%. Despite this, the broker cautions, the Singapore market is volatile and Singapore has more stringent regulation than Macau regarding international marketing agents. In Singapore they can only source high rollers and cannot provide credit to or share commissions with players. These are the key incentives which are used by these marketers in Macau to secure VIP business.
In terms of Australia's fledgling VIP market, Deutsche Bank notes turnover disappointed at both properties, up just 1.4% in the second half. This is an extreme contrast to the growth in the Macau and Singapore VIP markets. Melbourne was up just 0.5% and Perth was up just 3.9%.
It's not just about the glittering competitors offshore. Crown lost share in the second half and it is apparent to Credit Suisse that Echo Entertainment's Sydney outfit, Star, is using its VIP tax-rate advantage to offer more attractive commission rates to VIP players. Players choose venues for a variety of reasons but price is one. Before Crown Sydney becomes a competitor, Echo is expected to double turnover with existing capacity. Crown has not revealed how it will deal with the price disadvantage other than continuing to invest in venues. Over the medium term, Credit Suisse expects growth under 10% in Crown's VIP business, which will get a renewed focus when Crown Sydney eventually opens for business.