Paddy Power REDUCE BUY

Transcription

1 Gavin Kelleher Gavin.Kelleher@merrion-capital.com Reuters PWL I / Bloomberg PWL ID Paddy Power Rating Previous REDUCE BUY 29 January 2009 IRELAND GAMING Reducing forecasts due to concerns regarding gambling spend We are reducing our FY09 and FY10 forecasts due to concerns regarding the economic sensitivity of gambling spend in its Irish retail and online divisions. With an Irish consumer recovery looking unlikely until FY11, we believe downside risk remains. We are changing our recommendation to REDUCE from BUY previously. Year Gross Win EBIT EBIT Net EPS P/E P/CF EV/ EV/ EV/ Div End Margin Profit Sales EBITDA EBIT Yield Dec (EURm) (EURm) (%) (EURm) (c) (%) % % 2008f % 2009f % 2010f % Source: Merrion Stockbroker Estimates Market Cap Current Price 551.4m YTD Abs. Perf % Shares Outstanding (m) 47.5 Daily Trade Vol. (sh 000) 246, Week High/Low 25.00/11.60 Enterprise Value (EURm) Net Cash (EURm) 84.2 Free Float 90% Reducing forecasts due to concerns regarding spend in Irish retail and online division We are reducing our FY09 EBIT forecasts for the group by 17.8% to 46.9m (37.2% fall yoy) and our adjusted EPS forecasts by 16.5% to 91.9c. We leave FY08 unchanged at 74.7m. The key driver for our downgrade is our assumption that gambling spend by customers in both its online and retail channels is likely to come under greater pressure in the weakening consumer environment, particularly in Ireland. We would also note our forecasts incorporate a / rate of 0.94 compared to 0.87 previously. We are now forecasting FY09 operating profit of 8.7m in Irish retail (-69.7% yoy), 32.1m in online (-17.7% yoy), 3.1m in UK retail (+41.6% yoy) and 2.9m in Telephone (-37.1% yoy). Our revised forecasts sit well below consensus figures for the group, FY09 adjusted EPS of 110c and EBIT of 59.9m. We believe consensus estimates are likely to be reduced following results in March. Economic weakness and tax change have significant impact to profitability of Irish retail estate The economic weakness, along with the Irish betting tax change announced in November, will have a significant impact on the profitability of the group s Irish retail estate in FY09 and FY10. Our forecast of 8.7m FY09 operating profit compares to our expectation of 28.7m in FY08. While the issues impacting Irish retail bookmaking could well lead to opportunities for the group due to capacity reduction, we believe this is more a longer term issue. Given the low level of profitability that is likely in FY09 and FY10, the high sensitivity of profitability to sporting results could be a key concern for shareholders in the short-term. Uncertainty and relative valuation leads us to move our recommendation to Reduce /1 /0 9 In terms of relative valuation, the stock is trading on a significant PE premium for FY09 and at a slight premium on an EV/EBITDA basis. In the past, we have argued that a premium rating is justified. However, since the second half of last year Paddy Power has proved to be more economically exposed than its peers and significant uncertainty remains as to how average stakes will perform in the current challenging macro-economic environment, particularly in Ireland. It may be FY11 before signs that the business is recovering are evident. While the group s balance sheet strength, cash generative characteristics and dividend yield of 4.7% offer some support, we are changing our recommendation on the stock to Reduce from BUY. 300 F M A M J J A S O N D J PADDY POWER - PRICE INDEX ISHARES FTSE PRICE INDEX Source: Thomson Datastream Merrion Stockbrokers 3 rd Floor, Block C, The Sweepstakes Centre Ballsbridge, Dublin 4, Ireland Tel: Fax: Published By: Merrion Stockbrokers

2 Merrion Stockbrokers 2 Reducing FY09 forecasts due to lower online average stakes, a greater expected fall in Irish retail and sterling weakness We have revisited our Paddy Power forecasts in light of the increasingly weak consumer environment, particularly in Ireland. We leave our FY08 operating profit forecasts unchanged at 74.7m. However, we have revised our EBIT forecasts for FY09 downwards by 17.8% to 46.9m due to a reduction in our forecasts for the online division (due to lower average stakes), a reduction in our Irish retail forecasts and incorporating a / of 0.94, compared to 0.87 previously. We also make small changes to our forecasts for the UK retail estate and the telephone division. Our new forecasts imply adjusted EPS of 91.9c in FY09, down from 110c previously. Online sports betting Average stake per bet likely to come under further pressure in FY09 Given its limited history, there is no historical evidence to estimate the impact a recessionary environment will have on online betting. However, the key performance indicator likely to come under the most pressure is average stake per bet in its sports betting division, a fact which was highlighted by the group in its H1 08 results. In H1 08, the group reported average stake per bet of 23.38, which represented a decline of 18% on H1 07 (-8% currency impact and -10% underlying). The group noted that the underlying decline was driven by growth in active users (which suggests a mix impact) and the more challenging economic environment. Our forecasts for H2 08 assume that average stake per bet declines a further 19%, with an underlying decline of 10% and a currency impact of 9%. Table 1: Paddy Power Online Division Forecasts f 2009f 2010f Sportsbook Average stake Growth in average stake -5.7% -4.2% -18.1% -25.0% -5.0% Volume of bets Growth in bet volumes 70.1% 23.5% 34.5% 15.0% 10.0% Total Amount staked online sportsbook Growth in amounts staked (Turnover) 89.7% 18.5% 10.2% -13.8% 4.5% Gross Win Gross win margin 7.9% 9.2% 8.5% 7.6% 7.6% Online Gaming f 2009f 2010f Online Gaming Revenue (Gross Win) Growth in online gaming Revenue 65% 44% 17% 4% 8% Gross win margin 100% 100% 100% 100% 100% Gross win Total Online Gross Win Gross Profit Operating Costs Operating Profit Source: Company Reports and Merrion Estimates Looking into FY09, we believe that a further decline in average stake per bet is likely, as customers further reduce their gambling spend. In addition, sterling weakness is an issue given c.60% of its online sports bets originate in the UK. We are now forecasting average stake per bet will decline 25% to in FY09, due to an underlying decline of 15% and a currency impact of 10%. This compares to our previous expectation of a decline of 8.4%, which included an underlying decline of 3% and a currency impact of 5.4%.

3 Merrion Stockbrokers 3 We are leaving our forecasts for bet volume growth unchanged. During H108 the group reported bet volume growth of 41.8%, and we continue to forecast 27.5% growth in H208 and 15% growth in FY09. We believe that despite the weakened consumer environment, the group should be able to continue to deliver growth in bet volumes due to the active user growth it has previously reported, along with its continued new product introduction and innovation. Table 2: Paddy Power Online Active User Growth Online channel Active Customers 30-Jun Jun-07 % Change UK 143,137 98,791 45% Ireland & Rest of World 75,345 58,619 29% Total 218, ,410 39% Online Customers Product Usage 30-Jun Jun-07 % Change Sports book only 144,419 96,632 49% Gaming only 27,619 26,375 5% Multi product customers 46,444 34,403 35% Total 218, ,410 39% Source: Company Reports We base our forecasts on gross win margins at the mid-point of guided ranges for FY09, which assumes a normalized run of sporting results. For the online sports book, this implies gross win margins of 7.6% in FY09 and FY10. In FY08, our forecasts are based on a gross win margin of 8.5%, given favourable sporting results during the first half. For online gaming gross win (poker, casino, games & financial spread betting), we forecast underlying gross win growth of 10% in FY09. The group should be able to continue to deliver gross win growth due to active user growth and new product introduction (such as its financial spread betting offering). We are forecasting that online gaming gross win will grow 4% on a reported basis (10% underlying growth, -6% currency). Sterling weakness will also have an impact here, but the strengthening of the dollar more recently will help offset some of this decline given that online poker is played in dollar amounts. Our FY09 operating profit forecast of 32.1m for the online division is based on the following three key assumptions: (i) bet volume growth of 15% in sports betting; (ii) an underlying average stake decline of 15% (reported -25%); and (iii) 4% growth in reported online gaming gross win (10% underlying and -6% currency impact). However, average stake per bet could see a more severe decline in FY09, as consumers reduce their gambling spend. In the table on the next page, we highlight the sensitivities of online operating profit to different assumptions for bet volumes and average stake sizes. For example, if average stakes decline 30% on an underlying basis and bet volume growth was 15%, this implies operating profit for the division of 27.2m in FY09. This would reduce FY09 group EBIT by 10.6% from our new forecasts. Table 3: Sensitivity of FY09 Online EBIT to Change in Average Stake Assumption ( m) Bet Volume Growth 0% 5% 10% 15% 20% 25% % Underlying Decline in Average Stake per bet Source: Merrion Estimates 0% % % % % % % %

4 Merrion Stockbrokers 4 Table 4: Sensitivity of group EBIT to change in Average stake assumption % +/- versus our new forecast Bet Volume Growth 0% 5% 10% 15% 20% 25% % Underlying Decline in Average Stake per bet Source: Merrion Estimates 0% 2.3% 5.1% 7.9% 10.6% 13.4% 16.2% -3% 1.5% 3.1% 5.8% 8.5% 11.2% 13.9% -5% -0.8% 1.9% 4.5% 7.1% 9.7% 12.3% -10% -3.8% -1.4% 1.1% 3.5% 6.0% 8.5% -15% -6.9% -4.6% -2.3% 0.0% 2.3% 4.6% -20% -10.0% -7.9% -5.7% -3.5% -1.4% 0.8% -25% -13.1% -11.1% -9.1% -7.1% -5.1% -3.1% -30% -16.1% -14.3% -12.5% -10.6% -8.8% -6.9% Irish retail division consumer environment is a risk to FY09 average amounts staked per shop We have also revised our FY09 forecasts for the Irish retail estate. In its IMS in November, the group reported turnover (amounts staked) in Irish retail were down 9% on a LFL basis in October. We currently forecast Irish retail LFL turnover (amounts staked) to decline 6% in H208. In terms of FY09, we had previously expected LFL turnover to decline 5% in Irish retail (-9% in H1 & -2% in H2). However, we are reducing this to -10% for the full year. We have also reduced our assumption regarding new shop openings to 4 per year (from 8) in FY09 and FY10, which is below the group s targeted rate of 6-10 new Irish shops per year. These changes lead to us reduce our FY09 operating profit forecast for the Irish retail division to 8.7m from 12.2m previously. This level of profitability compares to our forecast of 28.7m in FY08 and highlights the impact the increased betting tax, a more normalised run of sporting results and the weakened consumer will have on the profitability of the Irish retail division. In fact, our forecasts for FY09 are based on gross win margins at the mid-point of guided ranges at 12.0%. Following the increase in the betting tax to 2%, gross win margin volatility now has a greater impact in percentage terms on the retail division s profits (as tax is derived from turnover and not gross win). For example, if the group was to experience a poor run of sporting results in the current year and gross win margins came in at 11.5% then our operating profit forecasts for the Irish division would be reduced to 4.3m from 9.2m currently. Again, given the limited historical data on how an Irish retail bookmaker performs during a recessionary environment, we have included a table on the next page which highlights the sensitivities of different levels of declines in average turnover (amounts staked per shop). For example, if amounts stakes per shop declined 15% in FY09 compared to our current forecast of -10% then operating profit for the Irish retail estate would be 5.8m compared to the 8.7m in our forecasts. This 15% fall would reduce group EBIT by 6.6%, assuming all other variables remain the same (particularly gross win margins which we assume at 12.0%) Table 5: Sensitivity to decline in Amounts staked in Irish retail & Impact to group EBIT Decline in average stakes per shop 0% -5% -10% -15% -20% Irish EBIT ( m) % +/- versus our FY09 group EBIT forecasts Decline in average stakes per shop 0% -5% -10% -15% -20% 13.3% 6.6% 0.0% -6.6% -13.3%

5 Merrion Stockbrokers 5 Consumer weakness and implications of tax change likely to lead to shop closures among smaller chains however may be FY10 before the benefit of this becomes apparent Given the downward revisions to our forecasts for Paddy Power s Irish retail division for the revision in betting tax and the weaker consumer environment, the pressure on the profitability of smaller chains and independent operators will be even more significant. There is currently estimated to be c.1,250 betting shops in Ireland, with a large number of these small operators and independent chains. These operators do not have the scale benefits of the larger players in the market such as Boylesports, Paddy Power and Ladbrokes. The new betting tax will come into effect in May this year, and these smaller operators will start to feel the full impact when they have to make their Q2 tax returns which we believe will be in H2 this year. In addition, with revenue and profit under pressure we believe increased closures are probable. However, it may be into 2010 before these closures start to accelerate. Paddy Power s market leading position puts it in a strong position to benefit from this when it occurs. We make small changes to our forecasts for UK retail estate and telephone division In re-examining our forecasts for the group we are making a small change to our forecasts for the group s UK retail estate due to weaker sterling. We are now forecasting the group s UK retail estate will deliver operating profit of 3.1m in FY09, compared to 3.4m previously. Our forecasts for the mainland UK division shops incorporate a 5.5% decline in average gross win per shop in FY09. In terms of our forecasts for the telephone division we have also made a downward revision. We are now forecasting operating profit of 2.9m from 3.6m previously. This downward revision has been driven by a reduction in our assumption on underlying average stake growth to 0% from +2% previously. While we expect average stake in this channel is likely to be impacted by the consumer weakness, the introduction of a higher stakes unit offering in H2 08 should help offset some of this weakness. With 45% of active telephone users based in the UK, sterling weakness is also having an impact.

6 Merrion Stockbrokers 6 Valuation and Investment View Our revised forecasts for group EBIT of 46.9m in FY09 represents a fall of 37.2% year on year. We would note these forecasts are below consensus expectations at present, but we believe consensus is likely to adjust downwards following results in March. While our expected decline in profitability in FY09 is partly driven by the impact of the weaker consumer, other factors are also at play including: (i) the increased betting tax charge in the Irish retail estate; (ii) weaker sterling; and (iii) the fact FY08 benefitted from a favourable run of sporting results in the H1 which means gross win margins for the full year are ahead of the mid-points of guided ranges. Our key concern for the group in the current environment relates to the impact the weaker consumer has on average stake sizes in its online division and its retail channel in Ireland (as this will impact amounts staked per shop). On our forecasts the group is trading on a PE rating of 12.6x (10.9x ex cash balance), which is a significant premium to its UK peers Ladbrokes and William Hill. On an FY09 EV/EBITDA of 7.1x, this premium is smaller. However, while we have argued in the past that the stock deserves to trade at premiums to these peers we would note that in the past 6 months it has proved to be more economically exposed than these peers, particularly its Irish business. Given this relative valuation, along with our concerns regarding consensus expectations, we are moving our recommendation to Reduce from Buy. Factors which can help underpin the valuation around current levels are its strong balance sheet (we forecast net cash at FY10 year end of 84.2m) and a dividend yield of 4.7%. Table 6: Paddy Power Comparative Table Company Country Price Mkt Cap m PE 08 PE 09 PE 10 EV/EBITDA 08 EV/EBITDA 09 EV/EBITDA 10 Div 08 Div 09 Ytd Perf Paddy Power (Merrion) IRL % 4.7% -11.4% Paddy Power (Consensus) IRL % 4.7% -11.4% UK Land Based William Hill Plc UK % 7.8% 12.2% Ladbrokes Plc UK , % 8.2% -2.4% Median % 8.0% Online 32Red Plc UK % 0.0% 45.0% 888 Holdings Plc UK % 6.2% -5.4% Bwin AUS % 0.0% 38.9% Opap(Greece) GR , % 10.6% 4.0% PartyGaming UK % 0.0% -12.0% Sportingbet Plc UK % 0.0% 14.2% Unibet Group Plc SE % 8.6% 16.1% Median % 3.1% Source: Merrion Estimates and Factset

7 Merrion Stockbrokers 7 Table 7: Paddy Power Divisional Forecasts Year to end December f 2009f 2010f Amounts staked LBO - Ireland LBO - UK Telephone Sports book Gaming Amounts Staked Gross win (Revenue) LBO Ireland LBO UK Telephone Sports book Gaming Online Gaming Gross Win Group Gross Win Gross Profit LBO Ireland LBO UK Telephone Online Group Gross Profit Operating Profit LBO Ireland LBO UK Telephone Online Group Operating Profit Source: Company Reports and Merrion Estimates Table 8: Paddy Power Income Statement Year to end December f 2009f 2010f Amounts Staked Gross Win Gross profit Operating Costs Operating Profit Associates Trading Profit Goodwill Amortisation Interest Non Recurring items Pretax Profit Adj Pretax Profit Taxation Tax rate 17.0% 17.2% 16.0% 14.0% 14.0% Minority/Other Net Income Adj Net Income EBITDA Year end number of shares Diluted Shares Average Shares Basic EPS Norm/Diluted EPS Norm EPS Growth 47.1% 60.9% 7.9% -32.0% 7.6% DPS DPS Growth Source: Company Reports and Merrion Estimates 56.4% 60.9% 7.9% 0.0% 0.0%

8 Merrion Stockbrokers 8 Table 9: Paddy Power Balance Sheet Year to end December f 2009f 2010f Fixed Assets Tangible assets Intangible assets Financial assets Total Current Assets Trade Debtors Other debtors Cash Total Current Liabilities Trade Creditors Other creditors Short term debt Total Total Capital Employed LT liabilities Lease Liab Other Net Capital Employed Shareholders Funds Share Capital Share Premium Reserves Revenue Reserve Shareholders Funds Source: Company Reports and Merrion Estimates Table 10: Paddy Power Cash Flow Statement Year to end December 2006f 2007f 2008f 2009f 2010f Operating Profit Depreciation Chg in Working Cap Other Operating Cashflow Interest Tax Capital Expenditure Free Cashflow Dividends Share Issues Acquisitions Disposals Other Cash Inflow / Outflow Cash at start of period Cash at end of period Source: Company Reports and Merrion Estimates

9 Merrion Stockbrokers 9 Disclosures Disclosure checklist - Potential conflict of Interests Stock ISIN Disclosure (see below) Currency Price Paddy Power IE ,11 EUR Source: Bloomberg closing prices of 28/01/2009 Key: 1. Merrion Stockbrokers Limited ( Merrion ) holds or owns or controls 5% or more of the issued share capital of this company. 2. The company holds or owns or controls 5% or more of the issued share capital of Merrion. 3. Merrion is or may be regularly doing proprietary trading in equity securities of this company. 4. Merrion has been lead manager or co-lead manager in a public offering of the issuer s financial instruments during the last twelve months. 5. Merrion is a market maker in the issuer s financial instruments. 6. Merrion is a liquidity provider in relation to price stabilisation activities for the issuer to provide liquidity in such instruments. 7. Merrion acts as a corporate broker or a sponsor or a sponsor specialist (in accordance with the local regulations) to this company. 8. Merrion and the issuer have agreed that Merrion will produce and disseminate investment research on the said issuer as a service to the issuer. 9. Merrion has received compensation from this company for the provision of investment banking or financial advisory services within the previous twelve months. 10. Merrion may expect to receive or intend to seek compensation for investment banking services from this company in the next three months. 11. The author of, or an individual who assisted in the preparation of, this report (or a member of his/her household), or a person who although not involved in the preparation of the report had or could reasonably be expected to have access to the substance of the report prior to its dissemination has a direct ownership position in securities issued by this company. 12. An employee of Merrion serves on the board of directors of this company. Rating History: Merrion s current rating for Paddy Power is Reduce and was issued on 29/01/09. Merrion s previous rating for Paddy Power was BUY and was issued on 06/07/07. We have not disclosed the recommendation to the issuer before its dissemination. Rating ratio Merrion Stockbrokers Limited Q Rating breakdown A Buy 44.8% Hold 48.3% Reduce 6.7% Not Rated/Under Review/Accept Offer 0.0% Total 100.0% Source: Merrion Stockbrokers Limited A: % of all research recommendations Merrion s rating system consists of three recommendations: Buy, Hold and Reduce. For a Buy rating, the minimum expected upside is 10% in absolute terms over 12 months. For a Hold rating the expected upside is below 10% in absolute terms. A Reduce rating is applied when there is expected downside on the stock. Target prices are set on all stocks under coverage, based on a 12-month view. Equity ratings and valuations are issued in absolute terms, not relative to any given benchmark. Job titles: The functional job title of the person/s responsible for the recommendations contained in this report is Equity Research Analyst unless otherwise stated on the cover Compensation: The research analyst (s) primarily responsible for the preparation of the content of the research report attest that no part of the analyst (s ) compensation was, is or will be, directly or indirectly, related to the specific recommendations expressed by the research analyst (s ) in the research report. The research analyst (s ) compensation is, however, determined by the overall economic performance of Merrion. Analysts own views: The research analyst (s) primarily responsible for the preparation of the content of the research report attest that the views expressed in the research report accurately reflect the analyst (s ) personal and current views about all of the subject securities or issuers. Stock prices: Prices are taken as of the previous day s close (to the date of this report) on the home market unless otherwise stated. Regulators Merrion Stockbrokers Limited ('Merrion') is a member firm of the Irish Stock Exchange and the London Stock Exchange and is regulated by the Financial Regulator. For further information relating to research recommendations and conflict of interest management please refer to

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