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Soft Outlook As The Star Cautiously Opens

Australia | Jun 02 2020

The Star Entertainment Group will re-open its Sydney casino and has also reached an agreement with the NSW government for future tax rates.

-Cash burn in the fourth quarter should reduce
-Earnings may not return to pre-pandemic levels until FY23
-Share price may have overshot, given pent-up demand is likely

 

By Eva Brocklehurst

The Star Entertainment Group ((SGR)) will re-open its Sydney casino, starting with private gaming rooms and up to 12 food and beverage venues in the casino area. Initially, this will entail thecasino's 500 loyalty club members by invitation only. These premium players are higher-yielding, yet operating costs will increase to $20m per month from June 2020.

Citi estimates this restricted period of operations will contribute to a break-even scenario for The Star Sydney and cash burn in the fourth quarter will be reduced to $193m, which should lower the risk of a capital raising.

Ord Minnett still expects consumer behaviour following the re-opening will be subdued, and earnings will not return to pre-pandemic levels until FY23. This is particularly the case as international VIP turnover will be zero through to December at least.

However, the majority of casino earnings are domestic, around 78% for The Star in the first half. The broker estimates revenue will be $1.82bn in FY20, down -27.2%. Normalised operating earnings (EBITDA) are expected to be down -39.3% at $337.8m. Ord Minnett models revenue relative to the previous corresponding period falling -56.5% in the second half, -54.1% in the first half of FY21 and -34.5% in the second half of FY21.

UBS brings forward expectations for the re-opening of the main gaming floors, from July 1. The opening of private gambling rooms plus a marginal benefit from subsidy should result in an improved result.

An earnings recovery over the next three years will also be affected by the opening of Crown Resorts' ((CWN)) Sydney  and Queen's Wharf Brisbane casinos. Star has re-rated from the March lows but underperformed the market by -25% in 2020 to date.

There have been strong revenue trends overseas, once casinos have re-opened, and UBS suspects there is also pent-up demand in the Australian market, assessing the share price has overshot. The market has de-rated Star Entertainment because of the closure of casinos following the outbreak of coronavirus, and expenditure by players is likely to be negatively affected by the impending recession.

Citi downgrades to Neutral from Buy, assessing the pace of recovery is uncertain. Once Queen's Wharf Brisbane is operational and earnings are normalised – around FY23 – Citi calculates Star Entertainment offers a 5.8 % free cash flow yield on a 7x operating earnings multiple at spot pricing.

In this way the stock no longer offers a significant margin of safety, given the competitive pressures and VIP restrictions. FNArena's database has five Buy ratings and two Hold. The consensus target is $3.26, signalling 7.3% upside to the last share price.

NSW Tax

Star Entertainment has reached an agreement with the NSW government to set the casino tax rates for the 20-year period FY22-41. UBS points out the announcement removes an overhang. In addition, there is the further protection related to exclusivity for gaming (slot) machines.

Instead of a progressive marginal tax rate, flat tax rates will operate as a percentage of non-rebate gross gambling revenue and will now be applied to domestic tables and electronic gaming machines.

The company will remain the sole casino with slot machines in NSW during this period, unless otherwise compensated. The government will provide compensation up until FY41 should Crown Sydney add electronic gaming machines.

The new tax on slot machines, at 32% in FY22 and rising to 34% over the period is slightly higher than Credit Suisse had modelled. But the extension of the current tax regime for another year, to FY21, was better than the broker had expected.

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