The jewel in the Crown

Chief Investment Officer and founder of Aitken Investment Management
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As you know, I think the Australian reporting season is going better than expected, with net upgrades to forward analyst estimates being the result of the majority of results.

This is very good news for my bullish view on the ASX200. Earnings (and dividends) being better than forecast, is a key required element of a bull equity market.

The majority of my key stock picks are stocks with headline earnings growth where that growth is under-priced in terms of the current market valuation.

I am particularly focused on stocks with US dollar earnings, and/or, a high proportion of their asset base in US dollars. This is based on my view of the AUD/USD heading towards 75 US cents in the years ahead, which should see domestic investors place a premium on US dollar earnings streams.

Focus on growth

Globally, investors are adding P/E to growth stocks. There has been a clear rotation from defensives to growth stocks, some of which is evident in Australian equities, as growth stocks start outpacing high-income stocks.

Source: Yahoo

Again, that is a required element of the extension of the bull equity market. The bull market started as investors were forced by central banks out of cash and sought income streams from equities.

Now, as global growth turns up and cyclical earnings turn up, investors are paying a higher multiple for growth and growth stocks are now leading all global equity indices. For example, the best performing sector in the US in 2014 is biotech!

I tend to look for growth at a reasonable price (GARP). It’s very rare to find grossly cheap growth stocks. What is more usual is to find reasonably priced growth stocks on current earnings, with future earnings underestimated.

The Crown view

Obviously, backing James Packer and Crown Resorts (CWN) has been a good idea over the last few years. Crown shares have doubled, and I get many questions from investors about whether I still think Crown is a high conviction buy at current prices. The simple answer is yes. Below I will explain why.

The real attraction is GROWTH.

On our forecasts, Crown will grow earnings per share by 35% in FY14, another 20% in FY15 and again by another 24% in FY16. That’s cumulative EPS growth of nearly 70% from FY14 to FY16.

However, on price to growth multiples, the market is not paying for that growth. The PEG ratio on FY14 forecasts is .54x, the FY15 PEG ratio is .79x and the FY16 PEG ratio is .53x. I always feel a PEG ratio under 1x in a stock with reasonably assured structural growth is “reasonable”. Crown’s PEG ratios are well below 1x in all three of the next financial years.

Part of this is driven by investors being conditioned NOT to expect dividend rises from Crown over the next three financial years. We all know how much Australians like dividends. Fair enough, the taxation and superannuation system rewards them, but there are times in growth stocks where it is better to invest for future growth than lift dividends. That is right now in Crown and our forecasts assume no lift in Crown dividends during the coming period of increased capex in Australia (Sydney).

A prudent strategy

We think holding the dividend flat and funding expansion from internal cash flows is prudent. It also shows you Packer is not greedy and not prepared to gear Crown too aggressively. In effect, he, as the 50% shareholder of Crown, is foregoing short-term dividend increase flow, to ensure the company is as financially strong as possible as it enters a period of higher capex.

In effect, the dividends from the brilliant Melco Crown investment will fund the Sydney development. Shareholders will not have to put their hands in their pockets. They will reap the big dividend reward in FY17 when capex comes off and free cash jumps.

It is worth spending a few moments looking at that Melco Crown (MPEL.NYS) investment. This is as good as you will ever see as a strategic investment. Crown own 33% of MPEL and paid US$600 million for that stake. That stake is now valued at US$7.8 billion and will account for 62.4% of our Crown NPAT by FY16. But, even more impressive, is the dividends that will now start flowing back to Crown as MPEL moves to a 30% dividend payout ratio.

We forecast that Crown will receive dividends of $116 million in FY14, $130 million in FY15 and $180 million in FY16, equating to a $426 million dividend stream in the next three years, which is over two thirds of the initial capital outlay for the MPEL stake. Now that’s a phenomenal total return investment and a reason CWN deserves a P/E premium to its industrial peers.

Our Crown Resorts (CWN) earnings forecasts are below.

Asian exposure

Crown is increasingly become a leveraged growth play on Macau. However, when we discount back out the MPEL stake and EPS/DPS contribution to our Crown valuation model, it appears to us that the domestic properties Crown own are now undervalued.

Some of this has been driven by valid short-term concerns about inbound VIP numbers and partially driven by regulatory uncertainty in Victoria regarding gaming machines. I feel both issues will resolve themselves, with the falling Aussie dollar likely to see VIP traffic increase, while the Victorian Government can’t be stupid enough to kill their golden goose.

It’s actually a re-rating of the domestic properties that get us to a $20.35 valuation and price target for Crown over the next 12 months.

I have no doubt that MPEL will keep performing and see that stock headed to US$50.00 per share, but I also feel, as sentiment headwind issues ease domestically, that investors will come to our conclusion and realise that the domestic assets of Crown are now undervalued in the Crown share price.

A big RSL

For those who live in hope that Crown will come back and bid for Echo Group (EGP) now that CWN shares have outperformed EGP so dramatically, I can only direct you to the timeless words of Darryl Kerrigan in the film The Castle: “Tell em they’re dreaming”.

As Crown Sydney comes out of the ground over the next few years, Echo shareholders will realise the only way for The Star to compete will be to go down-market and become a big RSL. Some would say it already is.

And consider this in the Echo/Crown debate. Echo spent nearly $900 million of capex on The Star for NO ECONOMIC return. In fact, earnings fell. Crown spent $600 million on a MPEL stake that is now worth $7.8 billion and paying $100m plus in annual dividends. I rest my case. These two stocks shouldn’t even be mentioned in the same breath.

I have long thought Crown Resorts was Australia’s only hope of creating a global luxury brand. That is occurring and the multiple for a luxury global brand stock is anywhere from 20 to 30x earnings.

On our forecasts, Crown is trading on just 12.8x our FY16 EPS estimate of 130c. If I am right and Crown does get re-rated to a global luxury brand, the minimum PE attributed to that FY16 EPS stream would be 20x. 20x 130c = $26.00 price target in three years’ time.

You can see why I am happy to forego short-term dividend growth in Crown to capture that potential capital growth over the next few years.

Crown remains a high conviction buy and a core portfolio holding.

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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