It’s been a very rewarding Australian (and NZ) reporting season for the AIM Global High Conviction Fund and hopefully for readers of the Switzer Super Report who followed our ideas this year.
The following stocks I’ve written on in these notes exceeded our profit expectations and continue to look solid investments into FY17. Link (LNK), Tourism Holdings (THL.NZ), Treasury Wine Estates (TWE), Baby Bunting (BBN), Class (CL1), Qantas (QAN), Southern Cross Media (SXL), Sydney Airport (SYD) and Transurban (TCL). The only slight disappointment came from Telstra (TLS), but that wasn’t a disaster.
This really is becoming more than ever a long/short stock-pickers market with wide performance divergence between those that exceeded expectations and those that didn’t. Thankfully, my fund is short some of the disappointers like Estia Health (EHE), Japara (JHC), and Woolworths (WOW). We expect those stocks to continue to underperform, while we also think the ASX200 as an index is fully priced around 5500 points and we have index protection on against what can be seasonally a bad month (September is a down month 60% of the time).
However, while we have some stock specific Australian shorts and some index protection on, we have increased our investments in Australian companies that passed the earnings test and have solid outlooks for FY17. I wrote last week that we had done exactly that in Treasury Wine Estates (TWE) and today I am going to explain why we have further increased our investment and conviction in Star Group (SGR). I last wrote on SGR at $5.30 and the stock has performed very well.
We thought the SGR result was excellent and we think the outlook for the group remains strong. On every metric we look at SGR more than passed the test and will continue to under the leadership of Matthias Bekier.
As you know, one of our structural growth themes is the rise of the Chinese international tourist. My view remains the rise of the Chinese international tourist is no different to the rise of the Japanese international tourist in the 80’s/90’s.
Australia remains perfectly placed in the time zone to capture a disproportionate revenue share of these Chinese international tourist dollars, as long as we provide the services the Chinese international tourist is seeking.
I want to start this note by re-visiting Sydney Airport data, Australia’s international gateway airport, to confirm this macro trend is highly relevant to Australia.
Clearly the data above from Sydney Airport confirms Chinese passenger numbers +19.6% vs pcp. That is a big tick in the structural growth theme box. You can also understand why Qantas (QAN) reported its highest profit in 95 years when you see these numbers and the network effect it has on domestic aviation.
While at this stage the vast majority of Star Group’s revenue comes from domestic customers, over the next five years we strongly believe the percentage of revenue derived from Chinese visitors will increase, particularly as SGR dramatically upgrades its accommodation offering in all its East Coast properties.
Quite simply, to us, SGR is doing everything right to capture a greater proportion of the Chinese visitor wallet in Australia.
To quote Matthias Bekier on the China opportunity from the SGR conference call:
“We think that right now only about 3% of our revenue comes from tourists. We also know that a surprisingly large percentage of particularly Chinese tourists find their way into our properties….around about 25%. So the attraction is there and the reason why we don’t get more is because we can’t get these people to stay on property. That’s one of the main drivers for us, to build out the hotel and the room capacity in our properties. If you think about it, the typical trip of a high-end customer right now is A$5,000 to A$8,000. We get A$150 of that. Why? – Because we are just a side trip. And for us to get a more substantial part of that wallet has to involve getting further up in the decision making chain, so working with the relevant tour operators in China to be more visible, but then most importantly, by having hotel capacity to get people to stay.”
This is a classic example of a company sensibly investing in growing their business ahead of a structural lift in demand for their product that is coming. Their investment in growth will be rewarded and so too will shareholders, through time, as their properties are upgraded and their revenues and margins lift.
If we look at the FY16 results, the trends are positive and the trading guidance for the first month of FY17 was also positive.
Importantly the commentary about new FY17 trading was positive. SGR stated that year-to-date FY17 normalised domestic revenue (ex-VIP) was +4.1% year-on-year in the period 1 July to 20 August. This is encouraging because the previous corresponding period was strong for SGR, therefore to grow again on that is positive vs these tough comps.
We forecast that this growth will remain across the current half yet then accelerates in the second half of FY17 to around +6% growth, as comps are softer vs pcp. We assume main gaming floor refurbishment disruptions at Star (Sydney) and Gold Coast hotel refurbishments will be complete by the end of 2016, thus enabling stronger growth in the second half of FY17.
All things being equal this should drive FY17 EBITDA to $605m +9% year-on-year and ahead of the current consensus forecast of $599m. Financial forecasts for FY17 and FY18 are in the table below.
On EV/EBITDA, SGR is cheap, trading on a 9.2x EV/EBITDA multiple. That multiple will expand in FY17 as SGR delivers on its strategy.
SGR has high cash generation and is a quasi-monopoly. Its monopoly position in Sydney will remain until at least 2021 by when SGR will be a completely revamped destination casino offering. The balance sheet is strong despite the increased capex spending on upgrading facilities.
SGR shares went ex the final FY16 dividend on Wednesday. They have also been slightly weighed on by market rumours that 6% shareholder Genting was offering their block around. If that were true I don’t think it’s an issue and that stake would be easily taken by investors including AIM.
When I last wrote to you about SGR I said: “I see no reason why SGR shouldn’t be re-rated up to a 20x multiple by investors as more become aware of the structural growth that lies ahead. 20x FY17 EPS of 32c sets a 12-18 month away price target of $6.40. I think that is a realistic price objective”.
Six months later and now with FY16 earnings confirmed I think the ‘realistic price objective’ is raised to $6.80, a price which, if achieved, would generate double digit total returns to SGR shareholders.
This is a well-run company with monopoly assets, growth projects, and a structural tailwind in terms of visitation. I think it’s one to buy and hold for the next three years, as Australia welcomes millions of Chinese international tourists.
After the FY16 results and commentary, we have even greater conviction in the SGR investment case and have increased our holding. Always bet with the house…
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