SkyCity’s Earnings are Returning as Restrictions Ease

Business Strategy & Outlook:

SkyCity to deliver strong earnings growth over the next decade, buoyed by the recovery from current coronavirus-induced lows and solid performance from its core assets in Auckland and Adelaide. SkyCity’s Auckland and Adelaide properties underpin the firm’s narrow economic moat. SkyCity is the monopoly operator in both jurisdictions, with long-dated licenses (exclusive license for Auckland expires in 2048, and Adelaide license expires in 2085 with exclusivity guaranteed until 2035). These properties have performed strongly, thanks to SkyCity’s solid record of reinvestment, resulting in high property quality, stable visitor growth, and earnings resilience. The quality of these assets, particularly SkyCity Auckland, has helped build the firm’s VIP gaming business.

SkyCity’s exposure to the volatile VIP gaming market is smaller than that of Australian rivals Crown Resorts and Star Entertainment. VIP revenue typically represents over 20% of Crown’s and Star’s sales, compared with SkyCity’s typical 10%-15%. While high rollers have no alternatives when in Auckland or Adelaide, SkyCity effectively competes as a destination casino on a global scale against locations such as The Star in Sydney and Crown Melbourne. The VIP gaming will be a negligible share of revenue in fiscal 2021 amid border closures. However, the segment recovered as border restrictions ease and tourism recovers, to around 15% of revenue. To protect its competitive position and retain appeal, SkyCity is investing in its key properties. Successful execution of the two major projects in Auckland and Adelaide is key. They provide good earnings accretion opportunities, in particular at the core Auckland property. This includes a NZD 750 million upgrade to SkyCity Auckland to be completed by calendar 2025 and a AUD 330 million expansion for SkyCity Adelaide, a transformational project completed in fiscal 2021. Beyond 2025, when these expansion projects come on line in full, SkyCity Entertainment is expected to resume generating excess returns and revert to a strongly cash-generating business on a substantially stepped-up earnings base.

Financial Strengths:

Despite near-term earnings weakness, SkyCity’s balance sheet remains robust, bolstered by a NZD 230 million capital raise completed at the end of fiscal 2020 and extensions to new and existing debt facilities. The firm received covenant waivers for the first half of fiscal 2022, given earnings weakness, and second-half gearing covenants are to be tested at double second-half EBITDA (rather than for the full year) with a higher testing threshold. While the higher threshold was undisclosed, the forecasted second-half net debt/EBITDA to rise to around 3.0–above the firm’s target range of 2.0 to 2.5, but comfortably below estimated covenant levels of closer to 5.0. The net debt/EBITDA is forecasted below 2.0 in fiscal 2023–below the target range of around 2.0 to 2.5. The completion of the NZD 330 million Adelaide expansion in fiscal 2021 takes some pressure off cash flows, and of the further NZD 500 million in capital expenditure flagged for the NZICC project, around NZD 380 million will be funded by insurance payments to be received following the NZICC fire. SkyCity’s balance sheet shall continue to improve over coming years as earnings recover, with net debt/EBITDA dropping below 1.0 in fiscal 2024 as expansionary projects roll off and earnings recover. SkyCity’s balance sheet will have the strength to continue paying around 75% of underlying earnings as dividends, while still being able to fund expansion projects at Auckland in the meantime.

Bulls Say:

Long-dated exclusive licenses to operate the only casino in Auckland and Adelaide allow SkyCity to enjoy economic returns in a regulated environment.
Transformative capital expenditure is expected at SkyCity’s Auckland and Adelaide casinos will lead to a sizable step-up in earnings.
SkyCity is well positioned to benefit from the emerging middle and upper class in China.

Company Description:

SkyCity Entertainment operates a number of casino-hotel complexes across Australia and New Zealand. The flagship property is SkyCity Auckland, the holder and operator of an exclusive casino license (expiring in 2048) in New Zealand’s most populous city. The company also owns smaller casinos in Hamilton and Queenstown. In Australia, the company operates SkyCity Adelaide (exclusive license expiring in 2035).

(Source: Morningstar)

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