Sin sector shares have traditionally been popular in bad times for the economy. Bad habits die hard, and vices ... well, they tend to linger. With this in mind, is it time for investors to place their bets on JSE-listed gaming stocks?
These stocks — casino operators and alternative plays such as limited payout machines (LPMs), electronic bingo terminals (EBTs) and sports betting — have given nifty turnaround payouts since slumping to near record lows in May 2020, when the Covid pandemic unceremoniously shut up operations.
Investors might recall that the Covid lockdowns brought the large casino counters — Sun International and Tsogo Sun Gaming — to a perilous impasse. Both counters held sizeable debt, which during normal operating conditions was comfortably covered by reliable cash flows. During the early lockdowns, there was no such cash flow, and balance sheets took more strain every day. Some very dire pronouncements were made by the market.
Sun hardly wasted any time before embarking on a R1.2bn rights offer (pitched at 944c a share), while Tsogo — controlled by investment giant Hosken Consolidated Investments (HCI) — preferred to sweat it out by honing its cost base and selling off smaller noncore nongaming assets.
It might be too early to make a definitive call about the respective strategies, with such developments perhaps best judged over a longer period. But the scoreboard will show that Sun, which delivered solid results and a stout dividend for the year to end-December, has had a remarkable run in its share price of late.
Sun gained about 25% in the first few months of 2023, and shifted up 55% over the past six months. That’s an extraordinary performance. But on a forward earnings multiple of nine and a dividend yield of more than 7.5% there may still be a few more upward strides. With Sun’s debt culled to a much more reasonable level, and with the option of selling off smaller casino properties to bolster the balance sheet further, dividend expectations are understandably high.
What was impressive in Sun’s results was that the Time Square casino near Pretoria not only continued to snaffle market share in a competitive Gauteng segment but also started building a fatter margin. Other major casino precincts — notably GrandWest in Cape Town and Sibaya in Durban — also performed well. On top of that, the 75%-owned Sun Slots LPM business continued to tick along despite ongoing load-shedding, while the sports betting business, SunBet, turned a profit after growing top line rapidly.
Sun hardly wasted any time before embarking on a R1.2bn rights offer
A quick glance at Sun’s balance sheet will offer additional comfort to investors. Group debt (excluding lease liabilities) has dropped from R7.1bn at the end of 2021 to R6.6bn. Sun’s ratio of debt to earnings before interest, tax, depreciation and amortisation (ebitda) is a more reassuring 1.84, well within lenders’ banking covenants of 3.25.
Share price movements in Tsogo have been more muted — up just 9% over six months at about R12.65. Still, this is a convincing recovery from the May 2020 pandemic low of 184c.
The last set of numbers to glean would be the interim results to end-September. But Tsogo should have a trading update out by mid-May for the full year to end-March.
Interim numbers were much improved, and the confidence the directors have that the business is continuing on a recovery trajectory was underlined by a half-year payout of 30c a share from basic and diluted adjusted headline earnings of 85c a share.
The interim payout should be viewed in conjunction with the acquisition of a 55% stake in the Emerald resort and casino in the south of Gauteng. Emerald is a small casino, but Tsogo will regard the shabby precinct as a “fixer upper”, and will need to spend substantial capital to ensure returns improve markedly. Tsogo’s willingness to grab Emerald speaks volumes about directors’ confidence in Tsogo’s ability to generate strong medium-term cash flows.
Cash flow from operations was more than R1.5bn in the interim period, and almost R1bn after deducting tax, finance and dividend payments.
In terms of balance sheet management — remembering that Tsogo did not opt for a rights issue in the Covid lull — the net debt-to-adjusted-ebitda ratio for the past rolling 12 months was 2.22. This is hearteningly down from the 2.89 of the end of March 2022.
Tsogo pointed out in its interim commentary that despite the completion of various transactions, net interest-bearing debt and guarantees were reduced by R535m to R8.5bn at the end of September.
The group’s medium-term target remains to reduce its net debt levels to lower than twice the adjusted ebitda — which seems quite achievable if the interim margin of 35.6% can be maintained (and even ratcheted up).
An improved performance at the Suncoast casino in Durban — which might have overspent on the capital front — will be key.
It’s worth noting that Tsogo’s EBT and LPM operations accounted for a chunky 20% of the ebitda line. Collectively, if the sports betting interests are added in, they donated almost as much as Tsogo’s KwaZulu-Natal hub, which consists of the sprawling Suncoast and the Golden Horse casino in Pietermaritzburg. This is an important statistic, as Tsogo is likely to have more expansion opportunities in its alternative gaming portfolio than in the traditional casinos in the next few years.
While the two large casino groups will probably be the most popular hands for punters, the two alternative gaming plays — RECM & Calibre and Grand Parade Investments (GPI) — are definitely worth a flutter too.
In early 2022 GPI was all set for selling off its assets and returning the capital to shareholders. The group had already sold off its dominant interest in Burger King SA and dished out its holding in Spur Corp. With Sun International an obvious buyer for GPI’s 25% interest in Sun Slots, as well as a 15% stake in Western Cape-based casinos GrandWest and Golden Valley (Worcester), it seemed the group was set to shut up shop and delist from the JSE.
But then investment company GMB, headed by former investment banker and gaming enthusiast Greg Bortz, came galloping out of nowhere. Bortz is well known in gaming circles — most notably for riding to the rescue of Kenilworth horse racing in Cape Town. Before anyone had time to blink GMB had ownership of nearly a quarter of GPI, which it then quickly expanded to trigger a mandatory offer to all GPI shareholders.
Sun, seemingly, was forced into action, and it, too, managed to buy a meaningful minority stake in GPI. Sun has effectively set itself up as a potentially obstructive shareholder that is able to block any special resolutions that might be mulled by GPI in the future.
At the close of the mandatory offer in early April, GMB spoke for about 53% of GPI. Investors might look at GMB-controlled GPI in a new light. The group offers, in effect, a “best of Sun International” — giving investors access to two of the most profitable gaming assets in South Africa: Sun Slots and GrandWest (which still enjoys a monopoly in the Cape Town area).
Then there is the inevitable speculation that GMB might look to revamp GPI by reversing other gaming assets into the listing, the Kenilworth Racecourse being an obvious contender. Sports betting assets would be another interesting proposition for GPI, remembering that Bortz already has close ties with the owner of Hollywood Bets.
The value proposition looks sound, with Sun remaining an obvious buyer for GPI’s gaming positions, but there is the added thrill of betting on Bortz to create additional value through corporate action. GPI’s shares are trading at a slight premium to NAV, which suggests the market is expecting action.
RECM & Calibre (RAC) holds a 58.8% stake in unlisted gaming specialist Goldrush, which offers EBTs, LPMs, online gaming and sports betting.
At last count (end-September 2022) RAC valued its stake in Goldrush, which is its only asset, at just over R1.2bn. There is about R260m in debt to subtract, plus capital gains tax and other liabilities of R100m. The point is that RAC’s NAV sits at about R877m, or R17.64 a share, vs a market value of R574m, or a share price of about R12.50.
That is a discount of more than 33% on a gaming asset that has mostly performed as well, if not better, than its more illustrious peers over the past seven years.
In the year to end-September 2022, Goldrush generated ebitda of R188m, which was 45% better than in the previous interim period. RAC indicated this was the highest 12-month “rolling” ebitda of almost R398m. This might give investors cause to consider the valuation that the group places on its Goldrush stake.
The two alternative gaming plays are definitely worth a flutter too
What is worth noting is that Goldrush’s strong profit performance was achieved with only a slight increase in the number of EBTs to 4,320 and gross gaming revenue coming in at R502m. At the end of the interim period Goldrush also had 2,812 LPM points — typically located in pubs or restaurants — with plans for more openings in the second half.
Understandably, Goldrush is competing in the sports betting and online gaming sectors as well, with these fledgling operations churning interim revenue of R54m and R40m respectively. The pace of growth in both these operations during the second half will be keenly gauged when RAC’s full-year results are released in late June.
By perusing investment company Astoria’s latest annual report to end-December, investors might get the slightest inkling of what has happened in Goldrush since RAC’s end-September results. Astoria holds about 16% of RAC. There’s not too much detail, but the annual report indicated that Goldrush had paid its first-ever dividend in 2022.
Investors might consider that the easy money has already been made on the JSE’s gaming stocks — especially as interest rate hikes, load-shedding and fuel price hikes have dampened discretionary spending. An improvement in the consumer mood also seems very unlikely in the short to medium term.
That said, Covid forced gaming companies to revisit their business models to ensure leaner and meaner operations, revisit gearing and hone capital expenditure plans. Certainly Sun and Tsogo are in better shape than before the pandemic, and should be pumping bumper profits when the economy is more vibrant. RAC and GPI should also kick on nicely and have the added benefit of potential corporate action, with both holding assets that are widely coveted.
IM considers that keeping a hand of Sun, Tsogo, RAC and GPI close to your chest for the next few years could pay off richly.
*The writer holds shares in RAC and HCI (the controlling shareholder of Tsogo)
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