Rising costs due to the Bell and Gotterson reviews, together with the prospect of higher NSW casino tax rates and competition from Crown Sydney has put another big dent into Star Entertainment’s earnings.
The fallout from the licence reviews in NSW and Queensland was expected to include higher costs for compliance and operations. The increased costs are estimated by SGR to be $35-45m in FY23f, with approximately half that amount to be recurring from FY24f. This was announced at the November AGM.
Now that Crown Sydney is open and competing directly with The Star Sydney, the earnings impact is beginning to emerge. SGR said its domestic revenue in 1H23f was down by -13.5% on pre-COVID levels. This includes the impact from Crown Sydney, but the company did not explicitly identify the direct impact amount.
More importantly, the new additional costs attributable to remediation actions and compliance requirements have caused operational costs to increase by about $20m in 1H23. This includes what SGR described as the use of ‘surge’ third party consultants to help improve compliance processes. Part of SGR’s plan now is to bring those extra resources in-house, permanently bulking up the administration. SGR is now implementing a range of measures that will add around $40m to group operating costs.
In December 2022, with a State election in view, the NSW Government announced increases to the tax rates on casino tables and gaming machines. This was ostensibly to align the tax rates with Clubs and Pubs, but it was clearly a political choice. The increase was also supposedly to align with a similar increase in Victoria leaving the door ajar for Queensland to follow. This copy-cat behaviour by the States signals the risk to SGR that casino regulation and legislation is de facto nationally designed.
SGR notes that the proposed casino tax rate changes in NSW require legislation to be passed unless the NSW Government and SGR reach agreement. Negotiations are underway. SGR says in the current form, the tax increases would have a “significant adverse impact” on the profitability of The Star Sydney.
The tax rate increases, in conjunction with the extra operational baggage have forced SGR to consider a non-cash impairment ranging from $400m to $1.6bn depending on whether the tax rate increases are implemented in full. The low end assumes no change in tax rate duties.
In contrast to Sydney, the Queensland casinos have been performing very nicely. Domestic revenue at The Star Gold Coast in 1H23 was up 30% on pre-COVID levels while the Treasury Brisbane equivalent revenue increase was +9%. Group revenue in 1H23 was therefore down 1% on pre-COVID levels.
Earnings and Guidance Lowered
The wash-up of all this is that SGR has lowered its 1H23 guidance for underlying EBITDA to $195-205m, and its FY23f underlying EBITDA guidance to $330-360m. Prior to this announcement, consensus FY23 EBITDA was $452m.
Investment View
Earnings forecasts for SGR must be in disarray right now. How a consensus can be formed is open to debate given the gaping hole in SGR’s earnings right now. Will the new forecasts envisage the same tax rate change in Queensland? Will cashless gaming become a national thing? And will SGR meet its obligations to be deemed suitable to hold its casino licences again?
There are outstanding fines yet to be issued against SGR to be considered as well.
The net asset value of SGR (freehold land, buildings, leasehold improvements and joint venture stakes) are worth approximately $3bn, or $3.15 per share. The market is simply ignoring this at the current share price of $1.52.
In our previous note (21 December 2022), we argued a capital raising was a possibility. This now seems more like a probability in order to reduce gearing below 2.5x. No dividend payments are likely before FY25f at this stage. We anticipate an equity raising in the vicinity of $500m at $1.25 per share would be sufficient to achieve gearing of 2.2-2.5x.
SGR is certainly down, but it is not out. The big Queens Wharf Development project in Brisbane and the various hotel projects on the Gold Coast can add substantial value to the group.
As a left field thought, we do not discount the possibility that Blackrock, owners of Crown Resorts, might see the opportunity to pounce on SGR. As we have speculated in the past, a combination of SGR and Crown would have substantial synergies.
Risks To Investment View
The delay in recovery of normal business conditions could suppress the earnings recovery for SGR. The Queensland inquiry is now complete and presents a risk if the findings result in a loss of license and/or penalties.
Recommendation
We have retained our Hold recommendation.
