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A thundercloud hanging over gambling group Ladbrokes Coral Group (LCL) appears to be lifting. Reportedly, chancellor Philip Hammond has intervened to shelve a review on "crack cocaine" betting machines where gamblers can wage £100 every 20 seconds on fixed-odds betting terminals (FOBT's).
Despite the Department for Culture, Media and Sport seeking to reduce the maximum stake to £2, the Treasury is allegedly perturbed this would slash some £400 million tax receipts from a total £1.8 billion spent via touchscreen, casino-type games. #
Critics point to such bets representing 96% of punter losses over £1,000 in betting shops and arcades, while defendants say gambling addicts would go online where bets are linked to a bank account, or just play for longer.
I cited this issue when drawing attention to Ladbrokes Coral last November, upon formal completion of the merger and with analysts raising price targets; it being difficult to determine whether a Theresa May government would "stand up for ordinary people," according to her rhetoric, with tougher regulation.
In the event, financial constraints appear to dictate, as government borrowing soars and the Tories ditch manifesto measures such as cutting free school meals and winter fuel payments.
It's actually unclear what extent FOBT's actually affect the group's income statement, within two-thirds of revenue derived from UK Retail. Anyway, the real issue is whether ongoing controversy invites tougher regulation, such as what a Labour government could do. For now, at least, the Tories appear to be backing off.
Latest trading statement improves the context
Despite last November's optimism for the merger, e.g. analysts at Shore Capital targeting a 180p base scenario to over 220p in a bull scenario, the stock fell from 135p as low as 111p from April to July.
Regulatory issues have continued to weigh: in January the sports minister proposed a mandatory horse racing levy of 10% of gross profits above the first £500,000, which has angered bookmakers, but been welcomed by the industry as a means of support.
A 4 May update for 1 January to 23 April 2017 was overall "in line" despite mixed sports results, and the general election delayed a regulatory review albeit with a tax on gaming free bets still expected from this October.
Such a mixed story appeared insufficient to support the stock. Indeed, a downtrend became established from 136p to 111p.
This ran into a firm inflection point though, with keen buying in the days surrounding a 27 July first-half trading statement that proclaimed: "£150 million synergies a year by 2019, more than double the original estimate"; strong digital performance with net revenue 17% ahead; albeit UK retail net revenue 6% down as a result of actions to raise margins which did improve retail profitability.
Total group net revenue edged up 1% on last year, with operating profit in a range of 4% to 7% ahead (on a pro forma comparison), which broadly affirms expectations for the full year.
Due to the raw merger effect, however, the financial table shows a profits re-rating with earnings per share (EPS) doubling.
It's perhaps more relevant to current perception how Company REFS cites three analysts upgrading projections (included in the consensus figures) for 2017 and 2018 - across profits, earnings and dividends.
They imply an undemanding price/earnings (PE) reducing to single figures and a material yield around 4%; quite as if the financial risk/reward profile tilts positively, if the regulatory issues can ease somewhat.
A reduction in volatility would improve the rating
Part of the dilemma for this stock has been ongoing volatility since it de-rated from over 243p in early 2013; the price then bumping along in a circa 100p to 150p range.
This means a relatively high "beta value" for market risk; quite why the balance of trading has kept the stock priced for a material yield as compensation.
An easing of the FOBT risk would take one such nasty out of the story, which ought to mitigate volatility, hence the PE multiple improve in respect of intrinsic growth.
Meanwhile, buyers at current prices can lock in a useful yield covered about three times by prospective earnings, backed also by (the table showing) a strong cash flow profile with modest capital expenditure needs.
A dilemma for conservative investors is goodwill and intangibles representing 186% of £1,435 million net assets (as of end-2016), with net tangible assets per share persistently negative.
Also, at end-2016, there was £1,089.5 million net debt, up from £304.1 million, with net interest costs shearing 26.8% of underlying operating profit in 2016. The financial review within the accounts cited new borrowings of £834 million and excess operating cash being applied to repay Coral Group borrowings; cash generated from operations rising a useful 29% to £212.9 million.
Not surprisingly, "principal risks" faced by the group included "availability of debt financing and costs of borrowing".
Although what extent of downturn the balance sheet may have to withstand, is debatable.
A cynical view is "addict businesses" such as alcohol, tobacco and gambling being relatively more consistent than bigger-ticket items like furniture and holidays.
So, the group's balance sheet remains another factor besides regulation, weighing on its stock, and management should provide more detail how they intend to reduce debt. But it doesn't appear the situation presents a risk as to covenants.
|Ladbrokes Coral Group - financial summary|
|year ended 31 Dec||Consensus estimates|
|Turnover (£ million)||1084||1118||1175||1196||1508|
|IFRS3 pre-tax profit (£m)||201||67.6||37.7||-46.5||-213|
|Normalised pre-tax profit (£m)||204||121||114||56.1||62.3||261||350|
|Operating margin (%)||18.8||10.9||10.0||4.5||5.2|
|IFRS3 earnings/share (p)||20.6||7.2||4.4||0.2||-17.5|
|Normalised earnings/share (p)||20.6||12.3||12.7||10.8||5.9||11.6||15.6|
|Earnings per share growth (%)||38.3||-40.5||3.4||-15.2||-45.5||97.8||34.5|
|Price/earnings multiple (x)||22.2||11.2||8.3|
|Annual average historic P/E (x)||9.8||11.6||8.8||11.9||21.0|
|Cash flow/share (p)||27.2||21.8||14.3||14.1||17.1|
|Dividend per share (p)||8.2||8.9||8.9||5.6||3.0||3.8||6.1|
|Covered by earnings (x)||2.6||1.4||1.4||2.0||2.4||3.0||2.6|
|Net tangible assets per share (p)||-27.0||-37.4||-38.0||-21.4||-64.2|
|Source: Company REFS|
You'll therefore notice, the stock hasn't done anything more than roller-coast in the nine months since I drew attention, with analysts positing circa 65% upside based on earnings potential.
Such views have been re-iterated. Indeed, numbers have been upgraded, but the price remains around 130p.
The chart, therefore, says the story has overall been too mixed - regulation and the balance sheet outweighing positives from the merger that helped upgrades - to rate Ladbrokes/Coral a "conviction buy".
Yet the government's possible climb-down on FOBT's - coinciding with the end-July up-tick in fundamentals - could prompt more recognition of value, hence the uptrend run from 111p continue.
It's tricky to set a firm target, with sentiment influencing quite as much as fundamentals, but a sense of risks reducing may anytime shift perception onto analyst forecasts in the region of 200p.
For more information see: www.ladbrokesplc.com/
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