Ask the analyst: Could Endeavour suffer from lower booze consumption and tighter gambling rules?
Could health concerns and legislation pose a threat to Australia's biggest liquor retailing and gaming group? Our analyst Johannes Faul has his say.
Mentioned: Endeavour Group Ltd (EDV)
Ask the analyst puts questions from Morningstar users (and occasionally myself) to our Australian equity research team. If you have a question about an ASX200 company or industry in our coverage, please email it to [email protected].
Today’s question
Today’s question came from Morningstar reader Phil, and it went roughly like this:
“Public bodies have become more vocal about health issues related to alcohol consumption and there also seems to be more of a push for restrictions on alcohol and gambling advertising. How are Morningstar’s analysts thinking about the downside risks this could pose to Endeavour?”
Let’s start by taking a quick look at Endeavour’s business for some context.
The ultimate sin stock?
Endeavour has two main business segments:
- Retail. This includes the Dan Murphy’s and BWS liquor store chains as well as Pinnacle Drinks’ portfolio of wineries, production facilities and private label brands.
- Hotels. Most of the profits here come from a 12,000 strong fleet of electronic gaming machines (aka pokies) located across Endeavour’s 350 pubs and clubs.
The retail side of Endeavour’s business is responsible for over 80% of revenue, but higher margins in the hotels business mean that the split of operating profit is closer to 65/35 in favour of retail.
Endeavour (ASX: EDV) was owned by Woolworths until its spin-off in 2021. The old parent-subsidiary relationship is survived through partnerships, Endeavour’s use of certain Woolies distribution assets for a few years post-spin, and the fact that many of the bottle shops are located next to Woolies supermarkets.
With all of this in mind, Endeavour is clearly going to view any potential shifts in the alcohol and gaming industries with interest. Let’s start with alcohol.
Drinking less but better?
Our reader’s first question was on whether health concerns, and a bigger push by public bodies to highlight these health concerns, will lead to lower alcohol consumption in Australia.
Johannes says that lower alcohol consumption on a litres of pure alcohol per person basis wouldn’t be anything new. Perhaps because of some of the concerns highlighted by our reader, Aussies are drinking far less alcohol on average than they used to.
As a result, increasing consumption of alcohol per person has not been a growth driver for Australia’s liquor market. Instead, the market has grown because of two trends: population growth and premiumisation, where consumers spend more to consume the same amount of alcohol.
Both trends are visible in the ABS data on per-capita alcohol consumption between 1945 and 2020 that is shown below.
The fall in overall volumes was led by declines in cheaper beer, while traditionally more expensive types of alcohol like spirits have seen consumption grow. There has also been premiumisation inside categories, exemplified by the rise of craft beers and higher average prices per bottle of wine.
Liquour sales (and the premiumisation trend) have been challenged in recent years as higher living costs and interest rates have led Australians to cut back on spending. This also caused the likes of BWS and Dan’s to be more aggressive in offering promotions at times.
Johannes sees this as a temporary hitch rather than the end of premiumisation in Australia’s liquor market. Meanwhile, the outlook for Australia’s population growth continues to look strong, with the ABS forecasting a 2030 population of between 28 and 30 million people from 2022’s 26 million.
Johannes thinks that Australia’s liquor retailing market can get back to mid-single digit annual growth over the medium term. As Endeavour enjoys a strong competitive position, he expects them to grow their sales and profits in line with the industry over time.
For more on potential threats and opportunities for alcohol companies today, take a look at my recent article on Brown Forman, the owner of Jack Daniels.
Endeavour’s edge in liquor retailing
Through Dan Murphy’s and BWS, Johannes estimates that Endeavour accounts for roughly half of Australia’s off-premises liquor market.
With more than double the market share of its biggest integrated peer, the liquor operations of Coles, Endeavour can fractionalise costs like advertising over a bigger base of stores and customers. This lets it keep more of each sale as profits than its peers while being aggressive on price.
These factors appear to be visible in Endeavour’s historical operating profit margins versus the competition. Endeavour’s liquor retailing margins have consistently come in at around 6%, while the liquor retailing operations of Coles which have usually languished below 4%.
Endeavour’s scale could also leave it well placed to fend off competition in the online space. Its huge network of stores already provides more convenient click and collect options than competitors, while brands may be unlikely to offer Amazon lower prices in fear of being destocked by BWS or Dans.
Let’s move on to gaming.
Pubs, but mostly pokies…
Endeavour’s hotels business includes around 350 venues across the country, with over a third of them located in Queensland.
The hotels business is a cash gusher for Endeavour. It boasted a pre-tax profit margin of 21.5% in fiscal 2024, a number you simply don’t get from food, drink or room sales. Instead, it mostly comes from approximately 12,000 licensed gaming machines located inside Endeavour owned venues.
Endeavour’s gambling business opens them up to further regulatory risk, says Johannes. In fiscal 2024, for example, Victoria’s government announced a raft of measures intended to limit play and reduce gambling related harm. This included mandatory carded play and more time between each spin.
After an initial hit to the firm’s Victoria operations, the rollout of these rules across the state’s gambling industry and the competition has set the stage for Endeavour to regain lost market share – with no signs that overall gaming activity has fallen significantly.
Johannes also points to the potential for hefty regulations to benefit Endeavour through the constrained supply of gaming machines.
Gaming licenses are capped at a state and territory level, and the number of licensed machines has not changed materially for the past two decades. Hotels that do have licensed machines are sheltered from competition and have been able to serve a growing population without an uptick in supply.
On the reader’s question about a potential clampdown on gambling advertising, this would likely be irrelevant to Endeavour. Its gaming venues trade under different brand (hotel) names, so mass advertising makes little sense anyway. TV ads are utilised more in other spaces like online sports betting.
Overall, Johannes forecasts low single-digit revenue growth in Endeavour’s gaming business going forward. He thinks that Endeavour’s share price at current levels more than accounts for the effect that any tighter gaming regulations could have on the business.
Latest earnings bring more of the same for shareholders
Endeavour’s shares have struggled since the spin-off and especially in the last couple of years. The key themes weighing on the stock over that time, softening liquor demand and rising operating costs, continued to make themselves seen in the company's H1 results.
If there was one positive in the liquor segment, though, it was that margins took a smaller hit in percentage terms than the competition. EBIT margins in EDV's retail segment shrunk from 7.8% in H1 last year to 6.7% this year, a 14% fall. Meanwhile, Coles’ liquor margins plunged by over 21%, falling from 4.2% to 3.3%.
Johannes says that this shows the resilience of Endeavour’s business despite significant industry headwinds. It also shows the attraction of having a moat that enables higher margins in the first place: it gives you far more breathing space when business isn’t so good.
Johannes remains confident that liquor sales growth will eventually get back on track, perhaps helped in the nearer term by a fall in mortgage servicing costs. Meanwhile, he expects that cost inflation will normalise, helping liquor operating margins to climb back towards their historical average of nearer 6%.
Markets, however, seem to doubt that the current retailer’s nightmare that Endeavour's liquor business is experiencing – a weakening top line and rising costs – will end any time soon. At a recent share price of $4.20, Endeavour continued to trade at a substantial discount to Johannes’ long-term Fair Value estimate of $6.10.
