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Single Party Risk: All Eggs In One Basket

Weekly Reports | Mar 24 2021

This story features CROWN RESORTS LIMITED, and other companies. For more info SHARE ANALYSIS: CWN

The New Criterion's Tim Boreham highlights ASX listed stocks exposed to single party risk and subsequent share price plunge risk

By Tim Boreham, Editor, The New Criterion

Last week your columnist delved into the issues facing stocks such as Crown Resorts ((CWN)) that rely on the stroke of a regulator’s pen to stay in business. (https://www.fnarena.com/index.php/2021/03/17/government-regulation-and-the-stock-market/)

As an extension of the theme, many companies rely on the whim of fellow enterprises to stay in business – or at least continue to operate in their current guise.

Single party risk comes in numerous guises. For example, a food and beverage maker can be ‘de-ranged’ by the supermarkets, leaving them with excess capacity and no alternative big enough to fill the gap.

Or an offshore brand name can cancel a local distributor agreement.

In the mining sector, offtake agreements can be cancelled – or service contracts scrapped – when commodity prices turn south (as they inevitably do).

Of course, companies protect their key relationships with long-term contracts, or their product or service to the customer cannot be replicated. For instance, we doubt the big Queensland coal producers using the recently listed Dalrymple Bay Terminal ((DBI)) will be upping stumps in a hurry.

But no deals last forever and, well, stuff happens. On the positive side, the loss of a major customer contract can result in a more diversified business.

Vita Group ((VTG))

As a case in point, the retailer last month came a cropper after Telstra Corp ((TLS)) decided to transition its retail stores to full corporate ownership by June 2025.

Vita is contracted to run 104 Telstra shops, with almost all of its revenue sourced from this franchise. The partnership dates back to 1995, when the company was founded by CEO Maxine Horne.

Vita’s management has not been oblivious to the threat, with Telstra slashing Vita’s commission rate by -10% in 2017.

The company has branched out with a chain of “skin healing and wellbeing” outlets called Artisan, which is touted as the future source of wellbeing for the company as well as clients.

Vita’s revenues dipped a covid-19 afflicted -25% to $323m for the half-year, with underlying earnings shrinking -27% to $16.1m.

Artisan chipped in modest revenue of $15m, up 37% as well as $2.2m of underlying operating earnings (EBITDA).

Vita shares tumbled -30% after Telstra hung up on the company, but the stock has regained some ground since.

With net cash of $30m, Vita has leeway to invest in a new future.

Over at Jumbo Interactive ((JIN)), the online lottery ticket portal is highly dependent on retaining the right to sell Oz Lotto and Powerball tickets on behalf of Tatt’s – now Tabcorp Holdings ((TAH)).

With a five-year deal expiring in 2022, investors were nervous but in June last year the parties extended this reselling agreement by ten years, to 2030.

Phew! Unlike with the previous deal, though, Tabcorp now clips each ticket to the tune of 1.5%.

In the meantime, management has been reducing this single-party risk by building up its lotteries management arm and its white-label arm which runs the raffles for Lotteries West and a number of charity lotteries.

Despite a dearth of jackpots, Jumbo’s December half revenue gained 9% to $41m, but the new Tabcorp “service fee” confined underlying earnings to a 4% gain (to $24.1m).

While Jumbo has almost a decade of breathing space, Tabcorp is under takeover offer and a new owner may take a different view on outsourcing the expanding digital channel to a third party.

But with the small but rapidly growing cloud and managed services arms, the $850m market cap Jumbo is not leaving its future to chance.

Jumbo, by the way, faces the ongoing risk of governments opening the lotto business to rival operators. But the Victorian experience of new lottery entrant Intralot which quit the market in 2014, investors can sleep soundly.

AMA Group ((AMA))

The crash repairer is not quite a case of single-party risk, but the lion’s share of its revenue now derives from insurer Suncorp Group ((SUN)) (owner of the AAMI and GIO brands among others).

That’s because AMA acquired 90% of Suncorp’s captive the Capital Smart smash repair business in late 2019, for $420m (Suncorp retained the remaining 10%).

Funded by a $215m capital raising and the remainder with debt, the deal almost doubled AMA’s share of the national smash repair market to 10%.

Crucially, Capital Smart also remains Suncorp’s “recommended repairer” status for a 25 year period, although the insurer can’t force all of its customers to use a Capital Smart repair shop.

A quarter of a century is a long time, although in your columnist’s experience it can pass quickly. Thus, investors should hope that AMA gradually reduces its reliance on Suncorp in the interim.

AMA, by the way, is worth a look as a post-coronavirus recovery play as traffic – and bingles – return to pre-covid levels.

The company’s average crash repair volumes fell -27% in the December half and 48% in Victoria which had an extra lashings of lockdown.

Given the Capital Smart acquisition the results are hard to make sense of, but in the first (December) half operating profit swung from a previous -$1.6m loss to a $7.09m profit.

In the year to June 2019 – pre the Capital Smart purchase and the raising – AMA generated earning per share of 6c (and paid a 3.7c per share dividend).

In the year to June 2020 earnings slumped to 1c. Broker Canaccord Genuity chalks in a partial recovery this year, to earnings of 3c.

Having traded at a pre-transaction peak of $1.48 in August 2019, AMA shares bottomed at 15c during the coronavirus a year ago and by November had recovered to 80c.

The stock looks fairly priced around the current 60c level – implying a $450m market cap – but looks keener value if the company can hammer out its dings and restore volumes to old levels.

AMA has two macro factors in its favour: wet weather and commuters’ aversion to using (allegedly) germy public transport.

Disclaimer: Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

Content included in this article is not by association the view of FNArena (see our disclaimer).

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CHARTS

AMA CWN DBI JIN SUN TAH TLS VTG

For more info SHARE ANALYSIS: AMA - AMA GROUP LIMITED

For more info SHARE ANALYSIS: CWN - CROWN RESORTS LIMITED

For more info SHARE ANALYSIS: DBI - DALRYMPLE BAY INFRASTRUCTURE LIMITED

For more info SHARE ANALYSIS: JIN - JUMBO INTERACTIVE LIMITED

For more info SHARE ANALYSIS: SUN - SUNCORP GROUP LIMITED

For more info SHARE ANALYSIS: TAH - TABCORP HOLDINGS LIMITED

For more info SHARE ANALYSIS: TLS - TELSTRA CORPORATION LIMITED

For more info SHARE ANALYSIS: VTG - VITA GROUP LIMITED