Opinion: A flutter on Sky City shares may become more of a gamble

By Simon Louisson of NZPA

Saturday 26th August 2006

A flutter on Sky City Entertainment shares five years ago most probably would have given a far greater return than a whirl on one of the casino operator's gaming tables.

Sky's share price has risen 160% over that period. In addition, the company is paying dividends equivalent to 5.5%.

The share price track from August 2000 for four years had few dips. Since 2004, it's been less directly up, with a couple of hefty setbacks caused by concerns about tighter pokey machine regulation and smoking bans. But it has been up nevertheless.

The 160% rise compares with a 107% rise in the benchmark NZSX-50 sharemarket index that includes dividends over the same period.

On the face of it, Sky's result annual result on Monday had little cause for concern. Headline profit was up 13% to $120 million on revenue up 12%.

New Zealand operations had recovered from the smoking bans implemented in December 2004, and the Australian operations had performed strongly as a result of new facilities and economic momentum.

True, higher expenses, depreciation and amortisation resulted in a 3% decline to $155m in earnings before interest and tax at the company's flagship Auckland operations.

And chief executive Evan Davies said warned broad economic factors, such as climbing petrol prices and higher interest rates, were leaving less money in punters' pockets and that would continue into 2007.

Despite the generally strong result, the company's shares fell 6% on the day of the result, although they have since clawed half that back.

So what did the analysts not like about the result?

Tyndall Investment Management equities manager Rickey Ward said it was the first time he could recall the company had voiced concern about economic factors.

"If your main revenue line is questionable, which is what it was in this result, then people are going to put questions marks on it."

Tower fund manager Paul Robertshawe complained about lack of clarity around one-off items and uncertainty about how to forecast Auckland earnings.

The latter may be because the company itself may not be too certain. Company chairman Rod McGeoch, in town this week for a tourism conference, confessed that some high rollers had dented the result late in the financial year.

He also expressed concern about high petrol prices reducing people's disposable income both here and in his native Australia, where Sky operates casinos in Adelaide and Darwin.

Analysts noted that over the last four years, first half revenues have grown markedly, but not at all in the second half.

Spending plans to upgrade casinos were bigger than had been flagged earlier, which is negative for earnings in the short-term.

However, analysts accept the need to spend, especially at Adelaide where local visitor numbers are less than usual for a city of its size.

The 1990s Adelaide casino is poorly located, and while Sky can't do much about that, it is trying to make it more convenient for punters to visit by adding car parks and so on.

Citigroup Research this week downgraded its rating on Sky to "hold/medium risk (2M)" from "hold/medium risk (1M)".

It also lowered its earnings forecasts, saying underlying revenue at the Auckland operation was a major concern.

"The group is heavily reliant on the performance of its core Auckland business, which accounts for around 70% of earnings," analysts Andy Bowley and Jenny Owen said.

They said any material change in performance in Auckland would materially impact on the group.

The analysts estimated average revenue from each gaming table had fallen about 24% in the second half of the year, compared to the first half.

"The key issue going forward in our modelling for the company concerns the normalised level of activity for Auckland's tables.

"While we believe ...there are several drivers in place...to support upward momentum for Auckland's tables from the current low base, we can no longer assume consistent growth is a given."

Citigroup reduced its forecast for Sky City's net profit for fiscal 2007 by 7.3% to $123.4m, and its ebitda by 3.3% to $322.5m. It lowered forecast net profit in 2008 by 9.9% to $128.4m and forecast a 3% drop in ebitda to $334.8m.

One factor underpinning Sky's share price has been expectation of rationalisation in the gaming industry in Australasia.

A bit of the heat went out of that last week after gaming giant Tabcorp withdrew its $A1.9 billion ($NZ2.3b) takeover offer for Queensland-based wagering firm Unitab. The bid was pulled after Tabcorp failed to get regulatory approval.

That cleared the way for rival Tattersall's planned "merger of equals" with Unitab, whose shareholders are scheduled to vote on the Tattersall's proposal in Brisbane on Monday.

Tabcorp may now run its ruler over Sky.

Davies would not comment on whether approaches had been made to Sky but added: "if somebody believes that the business is worth more than the businesses' shareholders believe it's worth, then they'll buy it".

Citigroup said any further consolidation in the sector would make Sky a potential bid target.

Although there are some concerns about Sky's short-term prospects, the company is still seen as a good solid company which is likely to perform well as the economy turns down. Apparently, as household incomes get squeezed more people turn to desperate measures.

One analyst, who did not wish to be named, said Sky's gaming machine business had showed very steady performance in the second half even after the higher petrol prices.

"Generally, the casino is more defensive than possibly other consumer-related industries within the retail environment.

"In an unsteady, uncertain environment, Sky tends to perform pretty well. Over the last five years, they tended to outperform when the market goes down, and trade sideways, or underperform, when the market goes up. It's a very defensive company."

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