How long have you held Tatts Group (TTS)?
We first purchased shares late in Dec 2011.
What do you like about it?
Primarily, we like the high quality lottery business, which makes up two thirds of our valuation for the group. In addition, most of the remaining third represents the lowest cost wagering product producer in Australia. Both businesses are buttressed by their exclusive long-term state-based licences.
We like the fact that today’s market-cap ($4.6 billion at 325 cents) is largely justified by a predictable non-cyclical after-tax cash earnings yield of 6%, with good growth prospects.
Retail stocks like Tatts Group should experience upside in an improving world economy because their distribution model allows for much higher internet sales margins. In particular, underlying volume demand grows at GDP plus 1-2%, in addition to price increases.
More importantly, the company represents an efficient source of tax revenue for state governments. Given the funding pressures many state budgets are under, Tatts Group represents an interesting exposure to increased lottery licence privatisation.
How is it better than its competitors?
The company’s lottery business does not have competitors in Australia. In addition, where the government-run licences have been acquired, Tatts management has demonstrated a consistent ability to enhance sales through sophisticated marketing and promotional activity, while controlling costs.
Remember this business represents long-term exclusive licences to distribute lottery products across all the states domestically (except WA), both on a state basis and pooled basis (for scale).
Tatts’ unique position as the lowest cost wagering product producer, due to its long term Tasmanian licence, provides an important competitive edge should the industry develop to allow full blown national competition. Note that Tatts Group currently has licences for only 20% of the market.
What do you like about its management?
The company’s management understands their competitive advantage lies in use of ‘negative working capital’ to generate very high returns by monetising intellectual property via electronic means. This business has no stock or debtors, no warehouse, or physical logistics. The divisional heads have good track records in growing the revenues of their individual businesses with significant operating leverage.
At the corporate level, there has been a change to the CEO – the retiring CEO has been replaced with Robbie Cooke, a well-known CEO (ex Wotif) with a good track record. The CFO has also recently been replaced with his extremely competent understudy, Neale O’Connell.
What is your target price?
We believe today’s market-cap of $4.6 billion represents attractive value, given the high degree of certainty for the 6% after-tax cash earnings yield, coupled with the high visibility on several years’ growth. We don’t use price targets.
At what point would you sell it?
We may sell the stock if the after-tax earnings yield becomes too thin (because the share price goes too high) or any of our underlying profit drivers change enough to negate the investment thesis of stable predictable and growing cash earnings.
By Rhett Kessler
Rhett Kessler is senior fund manager, Australian equities at Pengana Capital.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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