A recent announcement from embattled casino operator Star Entertainment (ASX:SGR) revealed that the company had burnt through $107 million in cash in the three months ending 31 December 2024.

Investors took the news to heart as the stock tanked 50% in the days following the announcement to make a minor recovery as the market waits for an update. The share price has disappointed investors after sinking almost 75% over the last year. Interestingly, a mystery Macau-based investor has been steadily increasing his stake in the past week, now owning 6.5% in the company.

Fears circulate for Star after recent spending suggests the operator would be lucky to survive till their interim results expected late February. Morningstar analyst Angus Hewitt considers a 50% chance that the company falls into administration and lowers his valuation by 60% to $0.20 whilst our going concern valuation is $0.40 per share.

The Star Entertainment Group Limited SGR ★★★

  • Fair Value Estimate: $0.20
  • Share Price: $0.14 (as of 16/01/24)
  • Moat Rating: None
  • Uncertainty Rating: Extreme
  • Price to Fair Value: 0.7 (Undervalued)

What led to the downfall?

The company’s core asset, the casino in Sydney historically generated most of the group’s earnings as the city’s only casino. This monopoly was toppled in 2022 as Crown Resorts entered the scene in a major blow to star.

In our view, the NSW government’s issue of the second casino license in Sydney stemmed from underinvestment and underperformance in The Star Sydney, depriving the state of taxation revenue. Star spent ~$500 million improving its Sydney facilities ahead of Crown Sydney’s opening however it was too little too late. We estimate that 30% of table revenue will be conceded to Crown Sydney within three years of the competitor’s operation.

In order to avoid a repeat of the above, the company is making an extensive effort to protect its exclusive position in Queensland through substantial capital investments. Unfortunately, due to the proximity of the Brisbane and Gold Coast casinos some cannibalisation may occur in the smaller gaming market.

Balance sheet woes

Star’s balance sheet is in precarious condition after their 8th Jan update. Elevated remediation costs in fiscal 2023, poor performance and fines increased led to two dilutive capital raises in 2023 at $1.20 and $0.60 per share.

This was the beginning of trouble as it proved insufficient to weather near-term earnings headwinds, amidst fines and equity contributions for the new Queen’s Wharf Brisbane development.

The fiscal 2024 collapse in earnings was considerably worse than estimated and development costs are set to be higher than anticipated. Buying time ahead of an expected equity raise in fiscal 2025, the company raised $200 million in emergency debt facilities at a sharp 13.5% per year.

Where to next?

Now we play the waiting game.

Several future updates detailing individual property detail and liquidity position should provide more clarity on the dire situation ahead.

Morningstar now prescribes a 50% probability that the casino operator falls into administration and equity holders are wiped out. The company may struggle to raise capital in current conditions after burning investors twice in 2023. Other options are to find potential suitors or sell individual assets to aid liquidity concerns. We believe that Star is unlikely to trade itself out of the current predicament.

Net losses in the next two years are expected before a rough break even in fiscal 2027. There are several other one-off costs in the horizon, with the securing of additional debt and material improvements in operating conditions being necessary to fund these obligations. We anticipate medium-term recovery in the operating conditions for casinos, but Star is in need of an immediate solution.

Average annual revenue growth is forecasted at 4% for five years ended fiscal 2029 as the business recovers from near—term headwinds, boosted by new developments in Queensland coming online. On the profitability front, operating margins will likely make a recovery to 11% by fiscal 2029 from ~3% in fiscal 2024.

Morningstar estimates Star has a fair value of $0.20 implying a price to fair value of 0.7, indicating the company trades at a discount to fair value. However, investors should approach with caution as the Uncertainty Rating remains extreme.

Bulls Say

  • Despite competition, Star's core Sydney casino provides an opportunity to turn around operations and grow in Australia's most populous market.
  • Star is well positioned to benefit from the emerging middle and upper class in China.
  • Long-dated licenses to operate the only casino in Brisbane and the Gold Coast, including licensed exclusivity in Brisbane, provide Star an opportunity to generate strong returns in a regulated environment.

Bears Say

  • Following inquiries, a more restrictive regulatory regime in Australia appears likely, weakening Star's ability to attract high rollers.
  • Increased levies could jeopardize The Star Sydney's profitability.
  • Star may compete aggressively with Crown Sydney for the reduced addressable postpandemic market, limiting earnings potential.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

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.

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 more about how to identify companies with an economic moat, read this article by Mark LaMonica.

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.