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A few days ago, a friend left an urgent message for me: "Make sure you buy a ticket in this week’s $100-million Powerball!". Lotteries are a low priority for me, but it’s amazing how a jackpot attracts interest – and sales for gaming companies – from people who don’t normally gamble.
To recap, the Powerball prize that was won recently by a Sydney woman, rose to $100 million in mid-January after no Division One winners surfaced in the previous week’s draw. The jackpot, unclaimed for eight weeks, is the largest in Australian history, matched only twice this decade.
Remarkably, one in three Australian adults were expected to buy a ticket in the draw, many of whom were not regular Powerball players. The $107 million win was the largest Australian lottery prize won by a single entry.
Mega-jackpots are important for ASX-listed Tabcorp Holdings, operator of Powerball. High-profile jackpots boost the company’s revenue, bring new customers to the game and stimulate repeat purchases. Mega-jackpots spark a blaze of free publicity.
Lotteries are huge business. The industry, worth $7.2 billion in 2017-18, delivered just over a half a billion dollars of profit from 288 firms, IBISWorld research shows. Tabcorp has a 37% market share of the Australian lotteries industry, by far the largest.
IBISWorld expects lotteries revenue to grow an annualised 1% over five years to FY18. Fierce competition from horse and sports betting, and from poker and gaming machines and online gambling platforms, has weighed on growth.
Annualised growth over the next five years will recover to 2.4%, predicts IBISWorld. Industry operators will benefit from greater household spending, more frequent lotto draws, online instant-win lotteries and other product innovations. An ageing population is another plus as older people tend to follow lotteries closer than younger ones.
Longer term, the lotteries industry has favourable traits. Entry barriers are high because it is hard for new entrants to compete with incumbents. Internal competition between operators is low because of the industry’s single State-based licence system. Tabcorp effectively has a monopoly in operating lotteries in the states and territories in which it operates.
Technology is aiding industry profitability. More lottery sales are occurring through digital channels; there is greater use of customer loyalty cards that encourage repeat weekly business; and lottery agents are serviced through online platforms. The result: lower wage expenses in lotteries and improving industry profitability over the past five years.
The market’s largest gaming company has a stranglehold on lotteries after its 2017 merger with Tatts Group and the Federal Government’s ban on synthetic lotteries, such as those provided by Lottoland. The synthetic lotteries ban, effective January 2019, boosted Tabcorp because it removed a potentially strong source of competition, at least for now.
Tabcorp has three core businesses after the closure last year of its disastrous Sun Bets joint venture in the United Kingdom and Ireland. Wagering and Media contributes 57% of revenue, Lotteries provide 36% and Gaming Services delivers the rest, Morningstar research shows.
Tabcorp has the dominant retail network in wagering through its TAB outlets and the Tatts merger has given it an extensive national footprint in lotteries. The problem, of course, is more punters migrating to online fixed-odds betting services offered by new entrants.
Online wagering businesses are advertising heavily in prime sporting events and encouraging younger punters to ditch bricks-and-mortar wagering outlets, such as the local TAB, for smartphone Apps and other online betting services.
As the industry incumbent with deep resources, Tabcorp is investing in technology and growing its digital offering. Management is doing a good job defending the company’s market position by growing online products and maximising the physical retail distribution network.
In some ways, Tabcorp reminds me of Flight Centre: another business with a strong store network that is migrating sales online and competing with formidable online-only rivals. To my thinking, blended models of bricks-and-mortar and online wagering, done well, have reasonable growth prospects. Do not write off Tabcorp’s digital prospects.
Moreover, the Tatts merger will give Tabcorp more stable, visible earnings growth. The lotteries business benefits from long-dated, State-based licences (Western Australian excluded) that create a large ‘economic moat’ around its earnings.
I like Tabcorp’s strategy: by expanding the lotteries businesses, the company is locking in a greater proposition of earnings, as competition from digital rivals in its wagering business grows. Also, the highly cash-generative lotteries division should give Tabcorp extra cash to reinvest in digital technology for wagering and lotteries innovations.
Over time, the lotteries business should increase its share of Tabcorp’s earnings, lower the company’s risk profile and enhance its capacity to pay higher dividends.
Macquarie Group this week said Tabcorp has had its best run with jackpot activity since 2000 and forecasted 18% revenue growth from this division in FY19. Last night’s $107-million jackpot draw will help drive that growth.
Macquarie also notes improving digital penetration rates with lotteries sales, which aids Tabcorp’s profit margins and encourages repeat business. Consumers who buy lottery tickets online tend to spend more on them than store-bought tickets.
For FY19, the investment bank expects flat growth in underlying earnings (EBITDA) in Tabcorp’s wagering business (excluding merger synergies) and 30% growth in the lotteries business, which is fast becoming a bigger driver of intrinsic value.
On Macquarie’s numbers, Tabcorp is trading on a Price Earnings (PE) ratio of 18 times FY21 earnings, or an 11% premium to ASX 200 industrial stocks. That seems reasonable for a company that has 90% of underlying earnings covered by long-term exclusive licences.
Macquarie has an outperform recommendation and $5.30 price target over 12 months. If it’s right, Tabcorp will deliver a total return (including dividends) of almost 20% over one year. An expected 4.7% yield, fully franked, at the current price is another attraction.
The market is not quite as bullish. An average target price of $5.19, based on the consensus of seven broking firms that cover Tabcorp, still suggests reasonable upside. Price targets range from $4.50 to $5.50. Morningstar values Tabcorp at the low end.
Tabcorp fell from almost $5 mid-September to a 52-week low of $4.14 during the market sell off. The stock has recovered to $4.58 and the rally has further to go.
Expect steady rather than spectacular gains in Tabcorp this year. Still, the company’s risk/return profile looks better than many blue-chips in an uncertain market and a possible 20% total return will stand out in a year when such returns are elusive.
Tabcorp’s first-half result for FY19, due mid-February, could be a re-rating catalyst.