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The one-year chart for the newly merged Ladbrokes Coral Group (LCL) is jagged. The market responded very positively to the merger proposal in July 2015, soaring nearly 50% to 162p in about six weeks, only to drop as traders protected fast gains amid regulatory uncertainties.
The Competition & Markets Authority's final approval has yet to revive the stock, which is trading at around 133p with daily volatility of a few pence ahead of the US presidential election.
Yet in the context of the medium-term chart, the shares appear to have hit a support trend-line and several brokers are entertaining forecasts higher than consensus (see table below), citing merger benefits.
On technical and fundamental grounds, it's time to reconsider the investment case for this £2.6 billion group while overall sentiment is cool.
I've drawn attention to Ladbrokes' 117-120p value since 2015, based initially on its scope to achieve growth through its digital offering. With a well-established brand and as gambling is an inherently British habit, Ladbrokes has a strong record of cash flow that is usually well ahead of earnings. It's also in the middle of a three-year marketing plan to aggressively grow sports betting, boost shop and digital revenue, and expand market share in Australia.
Directors have added to their holdings over the last two years, with chairman John Kelly buying 19,400 shares at 152.8p in August, bringing his total to 77,400. And senior independent director Mark Clare has just bought 50,000 at 130.35p.
Despite the subsequent fall, there hasn't been any change in the fundamentals since Kelly demonstrated belief in the long-term value. Barring a recession, Ladbrokes Coral isn't affected by Brexit, either. Perhaps the chief risk is regulatory, but diversified activities mitigate this.
Positive trading should support post-merger objectives to grow scale digitallyBoth companies have traded strongly this year, helped by the European Championships and early benefits from Ladbrokes' strategic review.
Despite variability within group operations, Ladbrokes reported a 12.1% increase in group net revenue for the third quarter of 2016: "We have delivered growth for a fourth successive quarter in group net revenue...our margin has been resilient, benefiting from focus on the recreational customer."
Meanwhile, Coral's similar period to 25 September shows net revenue up 8.9% - 11.3% for the year to date. That's good underlying momentum with no sign of jolts on the horizon. Online revenue growth was 24% at Coral and up 33% with Ladbrokes, helped by a low base.
Positive trading should support post-merger objectives to grow scale with its digital capability and also internationally, whilst achieving cost savings on a £65 million base-case scenario. The groups operates in a large growth market for gaming, with online especially attractive and cash generative.
Completion of the merger and a new ticker LCL has seen analysts promote their stances. Most bullish is Shore Capital, which effectively contends 65%-plus upside on scope for £65 million of declared synergies and ongoing benefits from the 2015 review. The broker expects operating profit to grow from a pro-forma £375 million (based on the merger) to about £500 million by 2018, giving earnings per share (EPS) of about 15p - way ahead of consensus 2016/17 projections.
On the board's dividend cover policy, payout and yield could rise to 5.8p and 4.3% respectivelyShore Cap's bull case scenario is based on bringing the cost/revenue per shop metric in line with rivals and growing the online operating margin towards 30%.
The latter should underpin operating profit of £650 million and EPS of 23p. The analysts' share price target of 180p in a base scenario therefore implies a price/earnings (PE) ratio of 12 times, or just 9.6 times in a bull scenario targeting 220p-plus.
Given the board's policy to make sure the dividend is covered two times by earnings, the payout and yield could rise to 5.8p and 4.3% respectively, constituting a more realistic prop than a sub-3% yield currently.
There is also optimism surrounding Canaccord's sums that £65 million of synergies represent just 3% of combined (estimated) 2018 costs. By comparison, this year's merger of Paddy Power and Betfair (to form Paddy Power Betfair (PPB)) is set to achieve 11% cost reductions, which is why analysts moot a target of £100 million savings at Ladbrokes Coral.
They see EPS potential of 11.7p for 2017, nearly 50% higher than consensus, along with a 5.8p dividend, and upgrade their 2018 EPS target by 65% to 13.9p. Debt is rising to achieve this, but is projected to reduce from 2.5 to 2.0 times operating profit by end-2018.
Online and overseas revenues represent 'significant hidden value'Looking within the business segments, the stock trades on a price/earnings (PE) discount to peer groups on a multiple of 11.4 times this year's earnings, which reduces to 9.6x for 2017 and 7.1x for 2018; hence a target of 165p per share. While this all looks a lot higher than in the table, consensus figures may not fully reflect merger benefits.
Morgan Stanley has just initiated coverage and looks even further out, with a 190p target based on a 23% compound annual growth rate in EPS from 2017 to 2019, driven by online growth, merger synergies and cash generation.
"We benchmark to its closest peer William Hill (WMH) and see higher growth, similar UK retail exposure, a larger online business and a significant valuation discount," the broker says.
Online and overseas revenues represent "significant hidden value" and the analysts' bear case on regulatory risks suggests a £100 million hit if the government clamps down on fixed-odds betting machines.
The government's review of stakes and prizes for UK gaming machines is expected to start soon, following calls from councils to slash the £100 maximum stake on fixed-odds machines to just £2-5. Critics claim they are based disproportionately in poorer areas and can be used for money laundering.
Buyers beware, but this is creating an attractive valuation relative to longer-term overall prospects"As ever, we will look for an evidence-based assessment of the facts," Ladbrokes Coral tersely responded; while the Association of British Bookmakers claims that these machines have been in betting shops for over 15 years, while problem gambling has remained at a constant 0.5% of the population.
Ladbrokes Coral is also working with the Treasury to consult over the fourth EU anti-money laundering directive. Quite whether a May government would seek to assert a more regulatory anti-business line, in the context of "standing up for ordinary people", it is too early to say.
So buyers beware, but this is creating an attractive valuation relative to longer-term overall prospects.
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|Ladbrokes Coral Group||Consensus estimates|
|year ended 31 Dec||2011||2012||2013||2014||2015||2016||2017|
|Turnover (£ million)||976||1,084||1,118||1,175||1,200|
|IFRS3 pre-tax profit (£m)||135||201||67.6||37.7||-43.2|
|Normalised pre-tax profit (£m)||154||204||121||114||52.8||77.4||90.3|
|Operating margin (%)||15.8||18.8||10.9||10.0||4.2|
|IFRS3 earnings/share (p)||12.9||20.6||7.2||4.4||0.5|
|Normalised earnings/share (p)||14.9||20.6||12.3||12.7||10.4||7.0||7.9|
|Earnings per share growth (%)||-65.9||38.3||-40.5||3.4||-18.2||-32.6||13.4|
|Price/earnings multiple (x)||13.2||19.6||17.3|
|Annual average historic P/E (x)||10.9||9.8||11.6||8.8||12.4|
|Cash flow/share (p)||20.7||27.2||21.8||14.3||14.1|
|Dividend per share (p)||7.7||8.2||8.9||8.9||5.6||3.1||4|
|Covered by earnings (x)||2.0||2.6||1.4||1.4||1.9||2.3||2.0|
|Net tangible assets per share (p)||-35.6||-27.0||-37.4||-38.0||-21.4|
|Source: Company REFS|
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