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Sun International bets big

Offshore expansion strategy was imperative.

After four-and-a-half years of a share price going nowhere, JSE-listed casino and hotel group Sun International has finally broken upwards and shareholders are breathing a sigh of relief.

Between June 2010 and June 2014, the share price floated between R80 and R109 per share and appeared to have no catalyst to rise. That all changed in the latter half of 2014 and the group is now trading north of R140 per share and it is sitting on a price to earnings multiple of around 24 times historical earnings.

Analysts have attributed much of this re-rating to aggressive management action to restructure the group portfolio and focus more on its offshore assets including a recently announced proposed merger with Dreams S.A. a Chilean-based group.

While this restructuring has brought short-term cheer to the group, the demanding earnings multiple can’t be ignored.

Allan Gray portfolio manager Duncan Artus unpacked the issues facing the company in an opinion piece back in September 2014 where he reminded Allan Gray clients: “Casinos are effectively local monopolies in South Africa since competition is restricted by the finite number of licences available. However, they do have to compete with spend on goods and services, as well as other forms of leisure activity.”

He pointed out that in many casinos 30% of visitors generate 70% of the group revenue, but the reality is that while casinos are still reporting decent numbers of visitors the rands being spent are in decline. Casino groups are also unable to raise prices without effectively altering the percentage of winners and losers. The group was also taking heat as a result of low occupancy rates in its hotel business, increased competition from Tsogo Sun and an African strategy which had until mid-2014 failed to deliver an acceptable investment return.

This required a major change which included the decision to spend more than R1 billion buying into Chilean assets which were arguably the most promising of the global opportunities.

At the time Artus pointed out: “With the major global casino operators focusing on Asia, Sun International has the opportunity to continue growing in Latin America without having to overspend to establish or acquire new casinos.”

Asset management firm RE:CM also began to beat the Sun International drum around the same time last year when it told clients: “Margins could be impacted by increased competition from limited payout machines and electronic bingo terminals (where Sun International also has some exposure), although these compete more with lower end casinos than the top end. There are also potential increases in gaming taxes and smoking legislation – changes to smoking laws had a big impact on their Chilean operation in the first half of their last financial year. Sun City also still unfortunately acts as a drag on returns on capital.”

RE:CM did however point out in January that it had begun to lighten its exposure to the group saying: “The company’s shares have featured as a holding in the fund for a long time and in the past year delivered strong returns. This followed some positive operational developments – cost cutting –instituted by the (relatively) new CEO, and a very elegant resolution to the uncertainty that has surrounded Sun International’s casino exclusivity in the Cape Town metropole for a number of years. This share price move prompted us to trim the position size somewhat, based on the changing margin of safety presented by the share price.”

While the international expansion strategy may have unlocked some short-term value for shareholders, it needs to be acknowledged that the company is having to work hard to reinvent itself and while it has been a big fish in the smaller local pool, it may find the going tougher in the more competitive global marketplace.

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