The Star Entertainment Group Limited SGR

Shares in The Star Entertainment Group Limited (“Star”) tanked last week after their first day back on the ASX in almost a month. This ended a prolonged trading halt further aggravated by a slap-on-the-wrist ASX suspension for failure to provide timely financial accounts. The longer-term investment case is clouded by the threat of Crown Sydney, liquidity risk and tightening regulatory measures. This article explores the once monopolistic establishment and why we believe its trading over 50% below its fair value.

  • Moat Rating: None
  • Fair Value: $0.67
  • Last Price: $0.27 (as at 1st October 2024)
  • Price to Fair Value: 0.4 (Undervalued)
  • Fair Value Uncertainty: Very High

 

When monopolies fall

Star’s core asset is The Star Sydney, which at one point was generating ~70% of the group’s earnings as the only casino in Sydney. The façade came crashing down in August 2022 with the state government issuing a second casino license to Crown Resorts, ramping up competitive pressure.

This came as bad news with Star’s performance historically lagging behind Crown casino in Melbourne, with both revenue and earnings falling short of its competitor. This long history of underperformance continues despite Sydney being the country’s largest city and international gateway to Australia.

Queensland is currently the only state where Star holds an exclusive position and consequently the company is throwing substantial amounts of capital (~$3 billion) in ensuring it stays that way. The Queen’s Wharf joint venture development in Brisbane commands $2.6 billion of the spending with a 99-year lease and 25-year exclusivity period.
Morningstar expects the extensive capital investment in Queensland to weigh on the near-term returns on invested capital. Further, we also believe the capital committed to facilities in Queensland might be disproportionate to the size of the addressable market.

So how does it measure up?

We estimate Star has a fair value of $0.67 implying a fiscal 2026 price/earnings ratio of 29.0x and an enterprise value/EBITDA of 15.0x.

Boosted by new developments in Queensland and a recovery from current headwinds, we project a 5% annual revenue growth for the five years ending fiscal 2029. Operating margins are forecast to recover to ~12% over the same period, however this remains below pre-covid levels considering the additional tax burden from the New South Wales government.

Undoubtably the presence of Crown Sydney results in a concession of market share from Star. It is approximated that Star will concede 30% of its table revenue within three years and 60% of VIP share by fiscal 2028. Nonetheless, the new competitive environment will necessitate improvement in both players and expand the Sydney VIP and premium gaming markets.

Inquiry woes in the rearview for now

The gaming sector carries a set of constant risks including tax increases, ESG risks, and heightened regulatory scrutiny.

Morningstar lowers our Uncertainty Rating from Extreme to very high after the results of the second bell inquiry were passed down. The scrutiny into Star’s suitability to hold a casino licence ended in the best plausible outcome that the company could have hoped for. Whilst they are currently deemed unsuitable to hold a casino license, the enquiry ruled that the license need not be revoked entirely.

On the other hand, Star continues to face potential operational risk at its Queensland facilities. This stems from material uncertainty around the considerable Australian Transaction Reports and Analysis Centre (“AUSTRAC”) fine after alleged non-compliance with Australia’s anti-money laundering and counter-terrorism financing laws.

Liquidity troubles amid expansion spending

With prevailing balance sheet concerns and liquidity risk, we assign Star a Poor Capital Allocation Rating.

The collapse in earnings since fiscal 2024 has indicated Star might not have sufficient liquidity to stay afloat amidst near-term earnings headwinds, the AUSTRAC fine and equity contributions to redevelopment. With a $200 million emergency debt facility at a rate of 13.5%, it appears Star may be buying time ahead of a potentially value-dilutive equity raise in fiscal 2025.

Star has arguably underinvested in its Sydney casino, however the $500 million sunk in improving its VIP gaming segment is unlikely to deter Crown casinos from capturing 60% of its VIP market share by fiscal 2025.

The company has taken an appropriate approach to shareholder distributions with the suspension of dividends during the pandemic. The remains their intention until suitable providing it remains within its target leverage range at the time. We expect dividends to resume in fiscal 2027.

Is the stock worthing buying?

There remains a large amount of uncertainty surrounding the future of Star’s earnings recovery. The pending AUSTRAC fine, eventual outcome of its casino license and a probable capital raise in the coming months all weigh heavy on its future performance.

Morningstar still expects earnings to recover in the medium term as the Queen’s Wharf development ramps up, cyclical discretionary weakness turns and regulatory costs ease.

The Star Entertainment Group Limited is currently rated five stars by our Analyst Rating and trades at 0.4 of its price to fair value on a $0.27 share price (as at 1st October 2024).

 

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Terms used in this article

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica