The Star Entertainment Group (SGR)
Equity Analyst Research Report
Prepared by:
| Name | Student ID | Component | Pages |
| Timothe Kessell | 44648480 | Component 1 | 2,3,4,5 & 10 |
| Alex Mellody | 43270476 | Component 2 | 9 |
| Dileepann Pious | 44647573 | Component 3 | 8 |
| TEAM EFFORT | Component 4 | 8,9 | |
| Priyanka Kapil | 43689876 | Component 5 | 6 |
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| Gaming, Entertainment and Hospitality Industry | ||
| Australian Stock Exchange (ASX) | ||
| The Star Entertainment Group | ||
| Date: 06/11/2017 | Current Price: | Recommendation: BUY |
| Ticker: SGR:AX (Bloomberg) | $4.97 AU (30/06/2017) | Target Price: $5.60 |
Source: Bloomberg, Team Estimates |
Executive Summary We issue a BUY recommendation on The Star Entertainment Group (SGR) with a one-year target price of $AUD5.60 using an equal weighting on both the DCF and relative valuations, offering a 13% upside on SGR’s closing price of $4.97 on 30th June 2017. SGR can capitalise on its growing domestic customer base to drive revenue growth in the face of volatile VIP earnings. – Valuation: Valuation through DCF and Multiples indicates a value per share of $5.60. SGR offers an upside through strong forecast growth and profitability margins, as they expand their Sydney and Gold Coast operations. – Growth Drivers: SGR has been able to stimulate revenue growth through domestic gambling growth. This growth was through implementing rewards programs and refurbishments. This increased stable income allows SGR to compensate for volatile international and VIP markets. They still seek to capture VIP market share with developments to attract them over competitors, with large developments such as the Ritz-Carlton. – Main Risks: Increasing competition from Crown Casino being granted a licence to operate in Barangaroo is a large consideration for the future of Star’s operations. This will provide an alternate Sydney location that caters to VIPs. There’s also the potential for their large development programs to be delayed and incur even larger costs, while their ongoing requirement of compliance with the high amount of regulations requires significant attention due to possible repercussions, such as losing their licence. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 7/29/11 7/29/12 7/29/13 7/29/14 7/29/15 7/29/16 7/29/17 SGR Historical Share Price |
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| Figure 1: SGR Total Revenue ($AUD Millions) Source: Annual Report Data Figure 2: Revenues per Segment Source: Annual Report Data Figure 3: Casino Visitation Segments Source: IBISWorld 0 500 1000 1500 2000 2500 69% 17% 14% The Star Sydney The Star Gold Coast Treasury Brisbane |
Business Description Star Entertainment Group (SGR) operates in the hotel/gaming, entertainment and hospitality industries. The entity operates in Australia in the states of New South Wales and Queensland and owns and operates The Star Gold Coast, The Star Sydney and Treasury Brisbane and is one of Australia’s leading integrated resort companies. SGR also manages the Gold Coast Exhibitions Convention and Exhibition Centre on behalf on the Queensland Government. SGR has focused on significant transformation projects in Sydney and the Gold Coast. Segments The Star Sydney – consists of hotels, apartment complexes, casino operations, restaurants, bars and the Marquee night club. It had 10.4 million guests in FY17, has 35 restaurants and bars and 606 hotel rooms, accounting for 69.3% of revenues (Figure 2). In 2017, all hotel rooms have been refurbished and the sovereign gaming room and gaming floor has been refurbished in a $1bn expansion in the Star Sydney, designed to attract overseas tourists. The Star Gold Coast – includes the Jupiters’ casino operations inclusive of restaurants, theatres, bars and night clubs. It had 3.4 million guests in FY17, has 14 restaurants and bars, 596 hotel rooms. Currently undergoing significant capital works for the luxury suite hotel and expected to open before the 2018 Commonwealth Game. This segment accounts for 16.4% of revenues (Figure 2). Treasury Brisbane – includes the Treasury casino operations, hotel, restaurants and bars. had 4 million guests in FY17, has 1 restaurants and bars, 127 hotel rooms. This accounts for 14.3% of the groups revenues (Figure 2). Sheraton Grande Mirage Resort – Acquisition of the Sheraton Grande Mirage Gold Coast was completed in 2017. This is a unique, beachfront asset that was purchased to attract tourists. Projects in Development Queen’s Wharf Brisbane Integrated Resort – SGR was granted approval to develop 12 Hectares in the Brisbane CBD for the Queen’s Wharf Brisbane integrated resort demolitions are underway and foundations work will commence in early 2018 with the expected completion in 2021. It will consist of 5 hotels with a $3bn development plan. Ritz-Carlton Sydney – This Ritz-Carlton’s (Sydney) development application will be formally launched in the FY18. This project is estimated to cost approximately $500m. Company Strategies SGR’s strategic priorities consist of five fundamental pillars: – Improving earnings across the Group, focusing on domestic gaming and operating efficiency: To reduce its exposure to the fluctuating demand by International VIP’s, that has an impact on the earnings and the shareholder returns, SGR has made efforts to strengthen its relationship with the domestic customers as approximately 67% of visitors are domestic (Figure 3). SGR has recently completed construction and redevelopment plans in Sydney and Brisbane and as a result of the improved gaming and non-gaming facilities, the revenues from domestic customers have been increasing, leading to stable operating costs. – Partnerships and Joint Ventures: The Star group intends to maintain its market share and increase its global competiveness through various partnerships and joint ventures. SGR has partnered with Hong-Kong based Chow Tai Fook enterprises and Far East Consortium International Limited to redevelop the Queen’s Wharf precinct in Brisbane, acquire the Sheraton Grand Mirage Resort along with redeveloping its Gold Coast Casino. This partnership has been a prodigious move for SGR as it not only increases its |
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| Figure 4: Market Share in the Australian Casino Industry Source: IBISWorld Figure 5: Australia Real GDP Average Growth Source: Australia Bureau of Statistics Figure 6: Revenues vs Employment growth Source: IBISWorld 38% 53% 9% The Star Group Entertainment Crown Resorts Limited Other |
access to capital but also deepens relationships and distribution of tourism channels in Asia that support the strategy of SGR in the tourism sector. – Capitalise on increased tourism to Australia: SGR is carrying out redevelopments in the Gold Coast to cater to the needs of the increased tourism as the Gold Coast will be an attractive destination because of the Commonwealth Games 2018. Although the group is intending to follow a capital light strategy by making no upfront payments for the construction of its 6-star tower at Jupiters Casino on the Gold Coast, SGR plans to sell the its share of apartments once they are completed which will fund the construction of the hotel without any capital outlay. – Differentiate the value proposition at each property: The Star intends to create a brand that delivers world class integrated resorts with authentic Australian spirit while being consistent with their premium services. In order to keep up with the increased local competition from Crown targeting the international VIP market, and to compete on a global level, SGR has made huge investments to refurbish and redevelop its existing casinos into World Class Integrated Resorts. This strategy targets a more diversified customer who’s inclined towards a great tourism experience and is driven by the growing tourism and consumer behaviour as consumers favour culturally authentic attractions with a local spirit that also offers gaming facilities. – Diversification into Global VIP and Premium Mass markets: SGR has experience a lower Chinese VIP turnover in the months of November and December. In order to mitigate the risk of this continuing trend, and the company revamped its business model and has started diversifying the customer base in order to reduce its reliance on the North Asian market. SGR is targeting only 50% of its international VIP income from North Asia and the other 50% from South Asia out of which 25% will be the ‘’premium mass’’ group in South Asia. This group comprises customers who will on an average contribute a significantly higher profit than general customers. Industry Overview and Competitive Positioning Industry Overview The gaming industry is expected to grow strongly over the next 5 years despite rising competition from overseas casino. Increasing tourism, particularly from China, has led to a rise in both VIP revenues regular tourist revenues. Both SGR (38.4% market share) and CWN (52.6% market share) are considered the largest players and have continued to dominate the industry domestically and account for 90% of the industry revenue (Figure 4). The industry is expected to grow steadily for in the next five years (Figure 7). Having only one Casino Licence available per state, the industry enjoys high barriers to entry and medium levels of competition. Local Demand Drivers Strong Australian Economic Growth The Australian economy has experienced continued stable performance and is expected to reach 3% in 2018 (Figure 6). Employment levels have increased in the last year but is expected to fall over the next few years. This is a positive for SGR in the short-term as there is a larger potential customer base, and their profits from domestic gaming are strongly tied to household incomes. Inflation has hit its lowest point in five years at 1.5%, however, it is expected to increase with the tightening of labour and product markets. Rising Real Household Discretionary Income Domestic table games business revenue has grown 5.7% in FY17 for SGR. However, this is expected to slow down as real house-hold discretionary income falls in the short term. Despite this, the increasing employment rate and inelastic nature of gambling |
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| Figure 7: Projected Casino Revenue Growth Source: IBISWorld Figure 8: Gambling Outlays per person Source: Productivity Commission Figure 9: Casino Table Games vs Ages Source: Productivity Commission Figure 10: Internet Gambling Revenues Source: Department of Social Services |
means SGR is still able to grow revenues. Revenue growth and employment growth appear to be heavily correlated and the forecast rise of employment in the near future is a positive sign for SGR (Figure 6). The Ageing Population Domestic demand for casinos is strongly correlated with the age distribution of the population. A Productivity Commission into the ageing Australian population predicts an increase in the proportion of older Australians as evidenced by Figures 8 and 9 This is expected to reduce domestic spending on casinos, directly impacting SGRs operations in the long term, as they will have to compensate for this decreased customer base. Global Demand Drivers Fall in VIP gambling The Chinese government’s reforms on gambling promotion on the mainland led to the arrests of 19 Crown employees and has resulted in decreased use of junkets (third-party casino promoters) for all casinos. As a result, SGR’s international VIP Rebate business turnover declined 29% in FY17, forcing them to rely and focus on domestic earnings. Increasing Tourism Tourism Australia predicts China will be Australia’s largest inbound arrivals market by 2017-2018. With an average casino spend of $834 per Chinese tourist, the increasing trends in Chinese visitors is encouraging for the Australian casino industry. The second largest casino spend per tourist came in at only $297 by Japan. The growth of the Chinese middle class is the driver behind this growth and the income from Chinese tourists is expected to rise by $4bn from 2016 to 2020. However, tourism is increasing in general, with higher tourism rates from south-east Asian and north American countries Trends in Online Gambling Australians spent over $1.1b in online betting in 2012, up from $928m in 2010. Figure 9 presents a strong upward trend in online gambling, underpinned by technological advancements in smartphone technology and faster broadband speeds. Online gambling includes games similar to those played on poker machines. It may be for this reason that the number of players of poker machines declined from 4.6m in 2011 to 4.4m in 2012. While this may be cause for concern for the casino industry, online gambling does not seem to have greatly impacted SGR’s profits, with revenues having grown from $1.6b in 2011 to $2.3b in 2017. Competitive Positioning Local Competition SGR has historically enjoyed strong barriers to entry in the regions they operate due to tightly controlled casino licences by State governments. In NSW, SGR is only recently facing increased competition with Crown’s issued licence in effect from 2019 Crown will, however, only finish construction of their six-star casino complex in 2021. International Competition International competition is highly concentrated, with large casino hubs in Macau, Singapore and other parts of Asia all competing for the same pool of South-East Asian VIP clientele. While these hubs are closer to the VIPs’ home base, Australia is very attractive due to being perceived as an ‘exotic’ destination. SGR is seeking to capture market share by catering to VIP tastes by building a Ritz-Carlton Hotel in Sydney and Brisbane. A brief look into SGR in relation to Porter’s Five Forces (a detailed analysis can be found in Appendix D): |
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| Figure 11: Composition of Australian VIP Market Source: IBISWorld Figure 12: Porter’s Five Forces Analysis Source: Team Calculations Figure 13: Annual Australian gambling expenditure Sourced: Roy Morgan Research 2014 |
Threat of Entrants – Insignificant Despite Crown’s entry in 2021, the threat of other entrants is low to non-existent. There are three reasons for this. First, casino licences are very expensive, with the SGR and Crown outlaying $100 million each for their licences. Second, the capital-intensive nature of the industry from large fixed assets means competition must be minimal to achieve acceptable profit margins. Third, the NSW government is not expected to grant additional licences. As the beneficiary of high licence fees and gambling taxes, they have an incentive to ensure competition is balanced to ensure maximum revenue from casino operations. Rivalry Amongst Incumbents – Low Crown has been granted a conditional licence restricting them to the VIP market. Conditions include: no gaming machines, minimum bets on table games and imposing a 24-hour cooling off period to new local members. This may lead to Crown ‘stealing’ some of SGR’s VIP base, which makes up 30% of their existing revenues. However, two state-of-the-art casinos may attract a much larger VIP base from which both casinos can benefit from; in any trip, VIPs typically visit 2.7 casinos. It makes sense that VIPs would visit both while in Sydney due to the casinos’ close proximity, boosting both Crown and SGR’s profit margins. Buyer Power – Moderate The three consumer segments include: small-time punters, the ‘junket crowd’, and VIPs. As mentioned, VIPs have historically accounted for 30% of SGR’s revenues. With $10m or more to gamble with, VIPs have a lot more buyer power than the local punter. For this reason, SGR will feel added pressure to satisfy this segment with the arrival of Crown’s VIP-exclusive value proposition. Crown’s $2b development has meant SGR has felt the need to inject $1b into refurbishments in order to provide a competitive offering. Such extensive refurbishments may lead to service disruptions; however, any resulting profit reductions are foreseen to be negligible. Supplier Power – Low Casinos’ superior bargaining position is a culmination of: undifferentiated product offerings by suppliers, high supplier concentration, ease of switching suppliers and availability of substitutes. While this is certainly the case for the food and beverage segment of their business, where, due to their economies of scale, casinos are able to secure favourable terms, suppliers of gaming machines have typically been in a more favourable position. The two major players have over 90% of the market, and have achieved strong returns. As evidence of this, Aristocrat Leisure Limited (ALL) has delivered a 10-year average net profit margin of 13% and a return on capital of 46%. This strong financial performance is representative of strong supplier power in this industry. Despite their apparent strength, risk of forward integration is deemed insignificant as incumbents are too well entrenched in terms of brand, expertise and existing licences to be threatened by such suppliers. Threat of Substitutes – Significant Tightly controlled casino licences have minimised direct competition. However, the casino industry is still subject to high levels of alternative competitive pressures including horse and sport betting, pokies found in bars and RSL clubs, lotteries and online betting (Figure 11). Switching costs between these products is low, with driving factors behind repeat patronage including: familiarity and habit, having a user or credit account with the service provider, desired service (horse betting vs. table games) and desired social experience. Due to declining revenues from other forms of gambling, substitutes have a low impact on SGR’s profits. Competitor Selection Criteria The comparable peer firms having been selected through an assessment of factors of the business profile and financial profile (Table 1 and Appendix C & G). Aspects of the |
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| Table 1: SGR Business Profile Comparison
Source: Team Calculations |
business profile include the sector the firms operate in, the products and services the firm offer, the end customers of the firm and geographic location each firm operates, in this case Australia. Further, the financial profile included size, profitability, growth and credit profile. Analysing this data indicates Crown Resorts (CWN), Tatts Group (TTS), Tabcorp Holdings (TAH) and Sky City Entertainment (SKC) are the most reliable peer firms to be used as comparables in the valuation process. (ALL was found to be a potential comparable to SGR in financial profile, however, they differed from SGR in business profile, operating in the supply of gambling machines, with different products and end customer, and were excluded from the list of peer comparables. Investment Summary We issue a BUY recommendation for The Star Entertainment Group (SGR) with a target price of 5.60AUD$ using an equally weighted 10-year DCF and Relative Multiples Valuation. A weighted average of these two methods was used to adjust for the limitations of each and therefore provide a more accurate valuation. The DCF is reliant on many future assumptions and highly sensitive to changes in these assumptions. The relative Multiples Valuation relies on comparable industry multiple as well as accurate valuation of these comparable companies by the market. Clearly, comparability can be difficult to achieve. The market has also proven that it does not always provide accurate valuations, such as extreme bearish and bullish period, such as the GFC. The key drivers of this recommendation include: Core Financial Drivers – Relaunch of the loyalty program driving momentum in private gaming room growth. – Maximise value from technology, including further enhancing gaming and loyalty experiences and delivering integrated and new IT platforms – Consistent revenues due to the potential addiction Drivers of CF – Strong Accounts Receivable Turnover (17.17) allowing quick acquisition of cash. – Improving SG&A while improving customer service experience driving increase margins. Drivers of Growth – Expansion projects in both Sydney and Gold Coast driving increased growth, particularly refurbishments in Sydney. – Successful management of risk factors – Loyalty program incentivising consumers to keep coming back, particularly relevant with the arrival of Crown in 2021. Business Prospects – We derived our target price using the Discounted Free Cash Flow to Firm method, and relative valuation Enterprise Value to Earnings before Interest Tax Depreciation and Amortisation. Drivers of Earnings Volatility – VIP market is volatile with the capacity for the house to lose and the substitutes available for them to attend. Financial Analysis
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| Figure 15: SGR’s Historical Key Financials Source: Bloomberg Dataset Figure 16: SGR Key Income Statement Items Source: Bloomberg Dataset 8 6 4 2 0 10 12 14 16 18 20 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017 Return on Assets Return on Common Equity Return on Capital EBIT Margin 0 2000 4000 6000 FY2012 FY2013 FY2014 FY2015 FY2016 FY2017 Revenues Cost of Revenue Selling, General & Admin Expense Net Income |
Overview |
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Table 2: WACC Computations
Source: Team Calculations
Source: Team Calculations |
Optimistic Outlook for the SGR’s Casino Business With diversification into global VIP and premium mass markets, improving operating efficiency, joint venture partnerships and the redevelopment of the properties to increase domestic gambling, SGR appears to have a positive future economic outlook. These strategies have also been backed up by the financial analysis and SGR appears to be heading to increased and steady growth for the next 5 years. Valuation The valuation method used to derive the target price for SGR include a 10 year DCF and Relative Multiples Valuation. DCF Valuation The Discounted Free Cash Flow to the Firm (DCF) approach was used to arrive at the intrinsic value of SGR’s share price of $5.82. This model was used because (1) SGR’s revenues and other Income Statement and Balance Sheet items are fairly predictable, and (2) DCF captures the underlying fundamental drivers behind SGR’s value. The model forecasts the next 10 years. The Adjusted Net Operating Income reflect capital lease commitments as well as the CapEx plans of SGR. The DCF is based off an N-stage Model as there has been heavy investment in expansion and development of existing properties and construction of new projects. These projects are expected to generate increased revenues at different stages throughout the 10-year forecast. The FCFF method is used as SGR is expected to undertake highly capital-intensive projects in the near future and would finance the majority of these project with debt. The FCFF model takes into account changes to the capital structure and incorporates this into the valuation through the WACC rather than cash flows. Additionally, due to the nature of SGR’s business, it will be difficult to continually expand as there is only one casino license allowed per state. Expanding into different businesses as they are doing with their Queen Wharf project appears to be the only alternative to their current solution. They have also just completed expansion and redevelopment of all casinos, so growth will increase but remain relatively stable over time. SGR can increase revenues by increasing operational efficiencies, which they have done leading to a large reduction in SG&A expense and a large increase in earnings compared to a stable growth in revenues. This model was formulated through assumptions from the historical and forecasted performance, an overview on the industry, and assessment of SGR’s competitive position. The following assumptions have been used to arrive at the DCF derivation: WACC The risk-free rate used was the 10-year Australian government bond yield (2.64%) with the credit default spread (0.248%) subtracted, estimated to be 2.39%. Since a current risk-free rate was used, a current implied equity risk premium was calculated through finding the IRR of the present value of the S&P/ASX200 ($5907) with a consolidated dividend yield (inclusive of stock buybacks during the period) of 4.1% and the I/B/E/S consensus estimates for the ASX200 earnings growth for FY18 was 13%. The adjusted risk-free rate (2.39%) was subtracted from the estimated Market Rate of Return (8.93%) to give the implied equity risk premium of 6.54%. The beta was determined through a weighted average of the SGR’s revenues per segment; hotel/gaming industry (90%) and the entertainment industry (10%). The firm’s capital structure was applied to arrive at levered fundamental beta of 0.732. Using the CAPM model, the cost of equity was determined to be 7.18%. The synthetic cost of debt was used and which determined by adding the AA rating spread for SGR (0.68%) to calculated risk-free rate (2.39%). The pre-tax synthetic cost of debt 3.07%, and the after tax synthetic cost of debt was 2.14%. The debt value is inclusive of the present value of operating leases, short term and long- |
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| Table 4: Relative Valuation Computations
Source: Team Calculations
Source: Team Calculations
Source: Team Calculations
Source: Team Calculations |
term debt. The target capital structure of 70% equity and 30% debt was used as determined by the median of selected peer firms. The market capitalization was used to determine the firms market value of equity and 30% target was applied to the enterprise value to arrive at the targeted debt. The combination of the above assumptions and computations equates to a Weighted Average Cost of Capital of 6.30% (Table 2 & Appendix I). Revenue Growth SGR will be able to sustain its high growth rate due to its sustainability of competitive advantage, having only on casino license per state ensures that the high barriers to entry remain and SGR can maintain competitive advantage. This will be bolstered with the expansion and renovation plans. However, with the introduction of the new casino at Barangaroo this may impact the VIP revenues. We used analyst consensus estimates for the first 5 years (10%) and tapered it down the next 4 years towards the growth rate of the terminal growth rate which was the Australian GDP forecasted growth rate. A 3- stage model was used for the valuation as a result of the forecasted revenue growth as shown in Figure 17. Terminal Growth Value The terminal growth value used is 3% and this is considered to be equivalent to the future Australian economic growth rate and expected inflation rate. This rate was used as SGR is considered to be at a mature stage in its business lifecycle with potential to continue with expansions and operates solely in Australia. Additionally, SGR is operating in an industry that is also considered to be in a mature stage. Relative Valuation Relative valuation was primarily focused on an EV/EBITDA multiple, with a EV/Sales multiple to corroborate findings. The EV/EBITDA multiple was chosen due to: – It being calculated independently of taxation and capital structure – The importance of EBITDA as a comparable pre-interest, pre-depreciation and amortization cash flow figure. The EBITDA for all peer companies had to be adjusted for non-recurring expenses and income, to better reflect the earnings for companies on average. This normalised EBITDA was used in the calculations of EV/EBITDA. The multiple was calculated from both the Median and Midpoint of peer comparables to guide our recommendation with more confidence. The benchmarking of 12 identified competitors based on the fundamentals of profitability, growth and risk (Appendix G) guided our decision on which were the closest peer comparables to use. The value per share for SGR calculated using the median and midpoint analyses led to a per share value of $5.38AU and $6.55 respectively for SGR, a ~8% or ~32% premium to the current trading price respectively (Table 4 & 5). Due the large premium from these valuations, EV/Sales multiples were computed as a check. The median and midpoint analyses led to a per share value of $6.13AU and $6.61 respectively for SGR, a ~23% or ~33% premium to the current trading price respectively (Table 6 & 7). This consistent premium over current trading price reaffirms our stance that SGR is undervalued and reinforces our BUY recommendation. Impact and Application Our BUY recommendation is based on our analysis that the market has adequately priced SGR’s current and future growth expectations. |
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| Figure 18: Historical EV/EBITDA Source: Bloomberg, Team Calculations Figure 19: Risk Matrix Source: Team Calculations Table 8: Risks and Mitigation Summary
Source: Team Calculations |
Investment Risks Impact and probability of the following risks are presented in the Risk Matrix in Figure 19. Regulatory Risks Failure to Comply with Relevant Regulations (RR1) The company operates in a highly regulated environment monitored by the Government and failure to comply with regulations, including taxation, disclosure requirements and casino operating standards may impact the firm’s financial performance, brand reputation and impacts the Group’s ability to maintain required licenses. To mitigate this risk, the Group has employed a Risk and Compliance Committee that monitors management’s compliance, governance and legal teams. Market Risks Reduced Market Share with Increased Competition (MR1) SGR has been operating the Star Sydney casino for the past 20 years with an exclusive license, effectively giving it a monopolistic positioning. SGR is facing increased competitive risk due to the impending expiry of the exclusive license in 2019 where Crown’s Sydney hotel and resort proposal has been approved. To mitigate this risk, SGR has significantly invested in the redevelopment of The Star in both Sydney and Brisbane to increase appeal to the VIP market and attempt to target increase domestic market revenues. Unfavourable Interest Rate Movements (MR2) SGR is exposed to moderate level of risk due to their bank loans and the size of their debt obligations. In order mitigate exposure to interest rate fluctuations, SGR has entered into fixed and variable rate debt, and uses interest rate swaps to hedge their underlying debt obligations. At this point 60.3% of their borrowings are at a fixed interest rate, down from 68.3% in 2016. Legal Risks Risk of Ineffective Governance (LR1) SGR faces a constant risk of failure to maintain potent governance structure to support a transparent, accountable and a compliant culture. In order to manage this risk, the group has devised policies to monitor the compliance on an ongoing basis. It has also devised a “3 lines of defence” model to recognise and control key risks and assure that critical controls are effectively in place. Risks of ineffective governance seem to be well controlled. Operational Risks Unplanned Delays in Development Projects (OR1) SGR’s strategy to expand and redevelop its casinos as integrated resorts calls for huge capital expenditure. The capital expenditure is susceptible to increased financial burden from interruptions, accidents, and natural disasters. Although the group has obtained the relevant regulatory, council and other planning and development approvals, the financial impact from the risks cannot be mitigated completely despite having insurance policies in place. Failure to Maintain Security (OR2) The company also faces the risks arising from inability to maintain the security and operating reliability of crucial business systems. Given that there is large amounts of money on-site thieves and criminal networks target these establishment in the form of cheating when gambling. To mitigate this risk, the group has the following in place: a dedicated IT function, highly sophisticated anti-theft and anti-fraud technology in their security system and highly trained employees. |
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Appendices
Appendix A: Statement of Financial Position (Forecasts and Actual)
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Appendix B: Statement of Comprehensive Income (Forecasts and Actual)
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Appendix C: Methodology for Selecting Peer Firms
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Appendix D: Porter’s Five Forces Analysis
Threat of Entrants – Insignificant
Under normal conditions, threat of entry into the casino industry is very low due to the high level of regulation. In
NSW, only one casino licence can be in force at any point in time (ABLIS 2017), effectively ensuring a monopolistic
position. However, with the discontinuation of this one-licence policy in 2019 (ABC 2013), the threat of entry has not
only become very real, but certain. Star’s main competitor, Crown, secured its own NSW casino licence in 2014 (Crown
2014, p.1) and will finish construction of its six-star casino complex in 2021 (Williams & Stensholt 2016). Despite
Crown’s impending entry, it is believed the threat of other entrants to be low to non-existent. The reason behind this
is three-fold. First, casino licenses are very expensive, with the Star and Crown outlaying $100 million (Lehmann 2014)
each for their licenses. Second, due to the capital-intensive nature of the industry due to the development of fixed
assets, competition must be low in order to maintain adequate profit margins. Third, no additional licences are
expected to be granted; the NSW government, as the beneficiary of high licence fees and gambling taxes, have an
incentive to ensure competition is balanced to ensure maximum revenue from casino operations.
Rivalry Amongst Incumbents – Low
While it is certain that Crown’s entry will have an impact on Star’s profit margins, the extent of such impact is yet to
be ascertained. Arguments that Crown’s entry will lead to positive and negative impacts on Star’s profit margins have
been proposed. Initial reaction to a competitor’s entry such as Crown’s may presuppose a negative impact on profit
margins due to an ensuing battle for market share. While this is a possibility, it is more likely the two casinos will use
their oligopolistic situation to their advantage. Crown’s license has been granted on certain conditions which make
their target clientele narrower than that of Star, including but not limited to: no gaming machines, minimum bets on
table games and imposing a 24-hour cooling off period to new local members (Lehmann & Clennell 2013). This means
that the Crown is more tailored towards servicing VIPs, which makes up 30% of Star’s existing revenues (Gandler &
Levin 2016, p.1). On the one hand, it may seem Crown will end up ‘stealing’ some of Star’s VIP base, thus reducing
Star’s profit margins. However, the existence of two state-of-the-art casinos may end up attracting a much larger VIP
base of which both casinos can benefit from; in any trip, VIPs typically visit 2.7 casinos (Knight 2016). Due to the
casinos’ close proximity, it makes sense that VIPs would visit both while in Sydney. This would end up boosting both
Crown and Star’s profit margins.
Buyer Power – Moderate
Buyer power in the casino industry is deemed moderate. There are three main consumer segments: small-time
punters, the ‘junket crowd’, and high-stakes rollers, also referred to as VIPs. The Australian Gambling Statistics 2014-
15 calculated average gambling losses were $1517 per person in NSW (as cited by Willingham & Preiss 2016). As
mentioned, VIPs have historically accounted for 30% of Star’s revenues (Gandler & Levin 2016, p.1). With $10m or
more to gamble with (White 2016), it is not surprising that VIPs have a lot more buyer power than the local punter.
For this reason, SGR will feel added pressure to satisfy this segment with the arrival of Crown’s VIP exclusive value
proposition. Crown’s $2b development (News 2016) has meant Star has felt the need to inject $1b into refurbishments
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Threat of
Entry
Rivalry
Amongst
Incumbents
Supplier Buyer Power
Power
Threat of
Substitutes
| Legend | |
| 0 | No threat |
| 1 | Insignificant threat |
| 2 | Low threat |
| 3 | Moderate threat |
| 4 | Significant threat |
| 5 | High threat |
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(Cummins 2016) in order to provide a competitive offering. Such extensive refurbishments may lead to service
disruptions; however, any resulting profit reductions are foreseen to be negligible. While attempts to curb buyer
power through loyalty programs have been made, such strategies have not been identified as effective from
preventing patrons from going to other casinos. Switching costs between direct competitors is therefore considered
quite low, with loyalty programs such as SGR’s ‘The Star Club’ seen as a necessary part of the service offering to
maintain competitiveness.
Supplier Power – Low
Due to the industry structures of supplying industries, casinos are well-placed to demand low prices on most products
and services they demand. Their superior bargaining position is a culmination of: undifferentiated product offerings
by suppliers, high supplier concentration, ease of switching suppliers and availability of substitutes. While this is
certainly the case for the food and beverage segment of their business, where, due to their economies of scale, they
are able to secure favourable terms, suppliers of gaming machines have typically been in a more favourable position.
With over 90% of the gaming and vending machine market (Aravanis 2017, p.3), the two major players in the gaming
and vending machine manufacturing business have been able to achieve strong returns for their shareholders. As
evidence of this, Aristocrat Leisure Limited (ALL) has delivered a 10-year average net profit margin of 13% and a return
on capital of 46% (DatAnalysis Premium 2016). This strong financial performance is representative of strong supplier
power in this industry. However, casino demand for gaming machines remains inelastic for two reasons: (1) electronic
gaming is the second largest source of revenue for the industry after table gaming (Wu 2017a, p.11), and (2) gaming
machines are replaced infrequently (the ATO determined effective life as seven years). Crown’s entry is not expected
to affect this segment of Star’s revenue due to Crown’s prohibition by the government on gaming machines (Lehmann
& Clennell 2013). Despite the apparent strength of gaming machine suppliers, risk of forward integration is deemed
minimal. Incumbents are too well positioned in terms of brand, expertise and existing licenses to be threatened by
such suppliers.
Threat of Substitutes – Significant
Tightly controlled casino licenses have minimised direct competition. However, the casino industry is still subject to
high levels of alternate competitive pressures. Punters can satisfy their gambling tendencies through other gambling
products including horse and sport betting, pokies found in bars and RSL clubs, lotteries and online betting. Switching
costs between these products is indeed low, with driving factors behind repeat patronage including: familiarity and
habit, having a user or credit account with the service provider, desired service (horse betting vs. table games) and
desired social experience. Looking at the breakdown in Figure 12, it is clear the most popular gambling activities (after
pokies) include racing betting, lotteries and sports betting. Declining horse racing attendances (Wu 2017b, p.5),
combined with uncertain future revenue growth (p.8) for the racing betting segment indicates low risk to SGR’s profits.
Similarly, IBISWorld indicates an uncertain future for the lottery segment (Wu 2017c, p.7).
16
Appendix E: SWOT Analysis
• Economies of scale
• Current monopolies in Australian
segments
• Global competitiveness
• Partnerships and joint ventures with
well-established Asian companies
• Addition of the Crown Sydney may
attract more VIPs to the Australian
market
• Increasing tourism due to the
Commonwealth Games
• Integrated resorts will boost the
interest of family-oriented visitors
• Increased competition from the
Crown Sydney
• Threat of increasing popularity of
substitutes (e.g. sport betting)
• Threat from the increased use of
technology (e.g. online gaming)
• Downturns in the business cycle
• International regulatory changes
(i.e. China banning gambling
promotion)
• Environmental calamities to
properties
• Geographically located further away
from VIP home-base
• Vulnerable to health of the local
economy (e.g. recession) and
demographic segmentation (i.e.
ageing population)
• Reliance on large proportion of VIP
base from South-East Asia
S W
O
17
Appendix F: Risk Matrix
18
Appendix G: Financial Profile Benchmarking
| Company | Ticker | Market Capitalisation |
Sales | EBITDA | Net Income |
EBITDA (%) |
Net Income (%) |
ROA (%) |
Implied Div. Yield (%) |
Tot. Debt / Enterprise (%) |
| Star Entertainment Group | SGR | $4,169.65 | $2,344.00 | $515.10 | $264.40 | 22% | 11% | 6% | 3% | 24% |
| Tier I: Closest Comparables | ||||||||||
| Crown Resorts Ltd | CWN | $8,459.05 | $3,282.56 | $828.00 | $343.10 | 25% | 10% | 21% | 5% | 27% |
| Tatts Group Ltd | TTS | $6,138.41 | $2,765.16 | $465.70 | $220.52 | 17% | 8% | 4% | 4% | 28% |
| Tabcorp Holdings Ltd | TAH | $3,650.26 | $2,234.10 | $476.80 | -$20.80 | 21% | -1% | -1% | 6% | 53% |
| SKYCITY Entertainment Group Ltd |
SKC | $2,700.39 | $927.30 | $321.50 | $44.86 | 35% | 5% | 2% | 5% | 27% |
| Mean | $5,023.55 | $2,310.62 | $521.42 | $170.42 | 24% | 7% | 6% | 5% | 32% | |
| Median | $4,169.65 | $2,344.00 | $476.80 | $220.52 | 22% | 8% | 4% | 5% | 27% | |
| Tier II: Other Competitors | ||||||||||
| Aquis Entertainment Ltd | AQS | $9.26 | $24.21 | -$6.02 | -$7.68 | -25% | -32% | -28% | – | 100% |
| Jumbo Interactive Ltd | JIN | $134.79 | $32.43 | $13.87 | $5.64 | 43% | 17% | 12% | 3% | 0% |
| Eumundi Group Ltd | EBG | $32.32 | $24.23 | $3.43 | $1.46 | 14% | 6% | 3% | – | 18% |
| Ainsworth Game Technology Ltd |
AGI | $715.15 | $282.08 | $70.30 | $37.93 | 25% | 13% | 8% | 2% | 16% |
| Mantra Group Ltd | MTR | $907.16 | $688.97 | $100.91 | $45.60 | 15% | 7% | 6% | 3% | 22% |
| Aristocrat Leisure Ltd | ALL | $10,072.86 | $2,128.70 | $807.00 | $350.50 | 38% | 16% | 11% | 2% | 54% |
| Donaco International Ltd | DNA | $482.10 | $136.35 | $66.43 | $30.99 | 49% | 23% | 5% | – | 18% |
| TopBetta Holdings Ltd | TBH | $37.18 | $5.62 | -$7.91 | -$7.62 | -141% | -136% | -59% | – | 0% |
| Mean | $1,548.85 | $415.32 | $131.00 | $57.10 | 2% | -11% | -5% | 3% | 29% | |
| Median | $308.45 | $84.39 | $40.15 | $18.32 | 20% | 10% | 5% | 3% | 18% |
The closest comparable companies to SGR were determined based on size, profitability, growth, and profit margin.
The difference in size was a major determinant on who could be included in peer firms, with many peers being
significantly smaller than SGR. This disqualified AQS, JIN, EBG, AGI, MTR, DNA and TBH from being part of our closest
comparable firms, as they were significantly smaller in Market Capitalisation. ALL, while similar in Market Cap and
across other margins to our identified closest peers was removed due to differences in business profile.
19
Appendix H: Comparable Companies and Multiples Analysis
In analysing the fundamentals of profitability, growth, and risk for SGR and direct competitors, our BUY
recommendation is supported for many reasons. Firstly, SGR generates a net income margin that is above both mean
and median figures for closest comparable firms, they also achieve an above average ROA with less gearing relative to
the median firms.
In addition to the EV/EBITDA, we also calculated EV/Sales, a common method of checking valuation premiums, to
corroborate our findings. Further calculating the Value per Share using both the Median and Midpoint to further
educate our BUY recommendation.
Current Trading Price (30/6/2017): $4.97
Premium: ~8%
Current Trading Price (30/6/2017): $4.97
Premium: ~23%
A competitor comparison based on multiples suggests that SGR is undervalued. Therefore, along with our other
valuation methodologies, we remain confident in our BUY recommendation on Star Entertainment Limited
EV/EBITDA Multiple Median
Enterprise Value from
Mean Multiple
$5,370.49
Less: Net Debt $931.30
Equity Value $4,439.19
Fully Diluted Shares
Outstanding
825.67
Value Per Share $5.38
EV/EBITDA Multiple Midpoint
Enterprise Value from
Mean Multiple
$6,341.59
Less: Net Debt $931.30
Equity Value $5,410.29
Fully Diluted Shares
Outstanding
825.67
Value Per Share $6.55
EV/Sales Multiple Midpoint
Enterprise Value from
Mean Multiple
$6,386.92
Less: Net Debt $931.30
Equity Value $5,455.62
Fully Diluted Shares
Outstanding
825.67
Value Per Share $6.61
EV/Sales Multiple Median
Enterprise Value from
Mean Multiple
$5,993.09
Less: Net Debt $931.30
Equity Value $5,061.79
Fully Diluted Shares
Outstanding
825.67
Value Per Share $6.13
Current Trading Price (30/6/2017): $4.97
Premium: ~32%
Current Trading Price (30/6/2017): $4.97
Premium: ~33%
20
Appendix I: DCF – WACC calculations
| Parameter | Value | Assumptions |
| Current Risk-Free Rate |
2.15% | Yield on 10-year old Government bond (21/Oct/2017) |
| Implied Market Risk Premium |
6.541% | Team Computations |
| Levered Fundamental Beta |
0.739 | Team computations |
| Cost of Equity | 7.23% | Team computations |
| Pre-cost Cost of Debt |
3.07% | Team computations |
| Marginal Tax Rate | 30% | RBA Australia |
| Post-tax Cost of Debt |
2.14% | Team computations |
| Target Capital Structure |
30% Debt 70% Equity |
Bloomberg and Industry Data |
| WACC | 6.30% | Team computations |
1. Risk-free Rate
The risk-free rate is 2.15% and was calculated by subtracting the on the CDS on the government bonds (0.49%) from
the yield on the 10-year Australian Government Bonds (2.64%). The 10-year bond was used in order to avoid any
reinvestment risk possibilities as a 10 year DCF model was used.
2. Market Risk Premium
The current implied equity risk premium was calculated through the dividend growth model and finding the IRR of the
ASX200 and using that as the Market Rate of Return (with GoalSeek in Excel). The parameters were the present value
of the S&P/ASX200 ($5907) with a consolidated dividend yield (inclusive of stock buybacks during the period [as at July
2017]) of 4.1% and the I/B/E/S consensus estimates for the ASX200 earnings growth for FY18 was 13%. The adjusted
risk-free rate (2.39%) was subtracted from the estimated Market Rate of Return (8.93%) to give the current implied
equity risk premium of 6.54%. The current implied risk premium was used because it is deemed the most accurate in
terms of correlation with the implied risk premium in one year and the actual risk premium over the next ten years
and to maintain consistency as the current risk-free rate was used. Implied Risk premium is a better proxy of the actual
risk premium than the average implied risk premium or the historical risk premium.
3. Beta
The fundamental bottom up beta was calculated. Both the Hotel/Gaming and the Entertainment were industries that
SGR is considered to be operating. The respective weightings were calculated from the annual report with gaming
revenues (90%) and non-gaming revenues (10%) proportioned to revenues. Worldwide industry betas were used in
order to eliminate the standard error of the beta estimation by increasing the sample size. This provided an unlevered
beta of 0.623. SGR’s debt value was adjusted to include the present value of operating leases, short term and longterm debt, the market value of equity was used and the effective tax rate was applied to arrive at the levered beta of
0.732.
4. Cost of Debt
The synthetic cost of debt was used and which determined by adding the AA rating spread for SGR (0.68%) to
calculated risk-free rate (2.39%). The pre-tax synthetic cost of debt 3.07%, and the after tax synthetic cost of debt was
2.14%.
5. Marginal Tax Rate
The Australian corporate tax rate is 30% and the 5-year average effective tax rate for SGR is 29.7% so 30% was used in
the calculation for the post-tax cost of debt.
6. Capital Structure
The target capital structure of 70% equity and 30% debt was used and was determined by the median of selected peer
firms and the worldwide industry average of the Hotel/Gaming and Entertainment Industries. The market
capitalization was used to determine the firms market value of equity and the target debt percentage was applied to
the enterprise value to determine the debt value used for the WACC calculations.
21
Appendix J: Free Cash Flow Estimation
Key Assumptions
Revenue: In 2016/17, 90% of SGRs revenue was driven by their gaming businesses. It has historically had strong growth
at 7.87% average over the past 5 years. Future growth in this segment is driven by a few factors;
– Expansions and renovations improving the customer experience and enabling a larger number of customers
– Capturing VIP market share through catering to their needs with future construction
– Growth in domestic gaming
– Rewards system to incentivise a continued relationship
– Breaking into new markets with acquisitions and developments in the Gold Coast
Moving forward, with developments such as the Queens Wharf in Gold Coast and Ritz Carlton coming to a head, we’ve
projected a high sales growth of 10% p.a for the next 4 years, in line with analyst consensus for their future growth.
SG&A Expenses: Based on Common Size analysis of SGR, we determined a downward trend in SG&A expenses over
the past 5 years, reaching a low of 78% of revenue in 2017. Despite this trend, we decided to maintain the latest SG&A
figure going forward, as there were no recent changes to drive a decrease as in previous years with refurbishments
being completed.
Capital Expenditure: A large proportion of SGRs growth is through extensive development of both existing properties
and new properties. Looking at their timelines for completion and respective costs, we have forecast a slight decrease
in CAPEX over the 10-year forecast, at dates where their major projects have significant completions, for example the
completion of luxury suites at the Gold Coast in 2019.
Appendix K: Discounted Cash Flow Analysis
22
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