Tabcorp and Tatts – a sure thing for the Melbourne cup

Financial journalist
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At Spring Racing Carnival time, Tabcorp Limited (TAH) is very much a stock to have on your side – because it is a guaranteed winner at the track.

Tabcorp “owns” the Spring Carnival. The company says that 74% of people who bet on the Melbourne Cup in New South Wales and Victoria will bet with it. As the Cup runners are paraded in the mounting yard tomorrow afternoon, Tabcorp will be processing 2,000 transactions a second.

Good odds

It will do 50 million transactions tomorrow – and you can take a tiny cut of each of them, if you own Tabcorp shares.

Tabcorp is a guaranteed winner tomorrow because it keeps about 17 cents of every dollar wagered: about one-third of this is paid to the relevant state government, about one-third to the racing industry, and the company keeps the rest. After covering costs – including an expensive ‘bricks and mortar’ retail channel – and taxes, about 3 cents of every dollar bet is clear profit to Tabcorp. That makes Tabcorp one of the Australian market’s great defensive and most recession-proof stocks – to put it mildly, Australians love to punt.

The other stock that is a guaranteed winner tomorrow, and on every other race day, is Tatts Group (TTS), which – although better known as a lottery operator – offers tote and fixed-odds betting in Queensland, South Australia, Tasmania and the Northern Territory, through its TattsBet division.

The traditional state TAB businesses run by Tabcorp and Tatts still represent almost 70% of the $26 billion wagered in Australia every year. The pair make up a highly lucrative wagering duopoly, but differ in the focus of their revenue: the lion’s share of Tabcorp’s revenue, just over three-quarters, comes from wagering; while TattsBet only contributes 21% of Tatts Group’s revenue – compared to lotteries, which generate 70% of the top-line. Tabcorp also has businesses in keno and gaming support services.

Yields racing ahead

These highly defensive revenue streams generate strong dividend yields. In FY14, Tabcorp is expected by market consensus to pay a dividend of 15 cents a share, rising to 16.6 cents a share in FY15. At the share price of $3.54, Tabcorp is offering a prospective FY14 fully-franked yield of 4.2%, which equates to 5.1% for an SMSF in accumulation phase, and 6% for a fund paying a pension.

For FY15, the prospective nominal yield is 4.7%, equivalent to 5.7% for a fund in accumulation phase, and 6.7% for a fund in pension phase.

The consensus expects Tatts Group to pay a dividend of 15.3 cents a share in FY14, rising to 16.4 cents a share in FY15. At $3.18, that puts Tatts on a prospective FY14 fully franked yield of 4.8%, which is effectively 5.8% to a self-managed fund in accumulation phase, and 6.9% to a fund paying a pension.

For FY15, Tatts Group’s prospective nominal yield is 5.2%, equivalent to 6.3% for a fund in accumulation phase, and 7.4% for a fund in pension phase. That’s not bad for yields based on highly resilient cash flows – if you don’t mind that those cash flows come from the pockets of the nation’s punters.

The risks

That is not to say that life is all plain sailing for the stock market’s bookies.

Both took a hit in FY13 from changes to Victoria’s poker machine licence regime, designed specifically to end the Tatts-Tabcorp duopoly. The new regulation, which took effect in August, scrapped the pair’s licences and took away their cut of $2.6 billion of poker machine spending in Victoria. In response, Tabcorp’s net profit fell 63%, to $126.6 million; while Tatts’ earnings fell by 22%, to $247.3 million.

But for its continuing operations, Tatts’ full-year revenue jumped 11% to $2.95 billion, while net profit surged 40.8% to $227.4 million. Tabcorp reported a 2% rise in revenue from continuing operations, but a 15.6% fall in earnings.

Then there is the clear and present danger of the entry of a big online wagering competitor from the British Isles. William Hill, one of Britain’s biggest wagering operators, spent $700 million setting up shop in Australia through the purchase of TomWaterhouse.com.au and Sportingbet (which owns Centrebet) in March this year. The Sportingbet and Centrebet brands will disappear, while the TomWaterhouse.com.au brand will remain until December 2015.

Sportsbet, owned by Irish bookmaking firm Paddy Power, and the Australian arm of UK online betting exchange Betfair, are also major competitors. (Betfair is slightly different because it allows punters to bet against each other, rather than against Betfair, and takes a cut of each transaction.) And just two months ago, famous British punting name Ladbrokes arrived in Australia with the $22.5 million purchase of local company Gaming Investments, which runs bookmaker.com.au.

Market makers

Of the $20.4 billion racing turnover, 31%, or $6.3 billion is transacted online, with the bulk being retail, on-course or telephone betting. Online has a much bigger share (52%) of the smaller sports betting market, which turns over $3.2 billion a year.

In online wagering, Tabcorp holds the biggest share of the market, at 26%, but Sportsbet (21%) and William Hill/Tom Waterhouse (21%) are barking at its heels. Betfair has 14% and Tatts has 6%, with other companies and other TABs accounting for the rest.

Through strong customer management i.e. barring consistent winners – the corporate bookmakers are enjoying gross margins of up to 14%. They also pay only 2 cents of every dollar of revenue to the racing industry, they do not have Taborp’s expensive branch network costs, and they pay less in tax than Tabcorp and Tatts, because they are usually domiciled in the low-tax Northern Territory – which hosts no less than 12 corporate bookmakers. All told, the corporate bookmakers could be netting 6 cents of every dollar of revenue as profit – which is why the big British firms have jumped into Australia with such gusto. They want to cut Tabcorp’s and Tatt’s lunch.

Tabcorp has the great advantage of the iconic brand in wagering – TAB – and its digital platforms complement its retail distribution business in New South Wales and Victoria. The British threat is smaller for Tatts Group, because it relies less on wagering revenue, but it cannot ignore either a suddenly more competitive wagering business, and will need to be on its marketing and product development toes.

But remember, these two still win on every bet. And while I’m picking winners, here is my Melbourne Cup box trifecta:

  • Fiorente
  • Voleuse De Coeurs
  • Green Moon
  • Mount Athos

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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