Hitting the jackpot
Shares in Aim-traded online casino operator 32Red (TTR: 67p) have now produced a total return of 34 per cent since I initiated coverage when the price was 51.75p ('Game on', 8 Jul 2013). Since then we have also banked a special dividend of 2.5p a share in early August and an interim payout of 0.8p a share in September. To put this performance into some perspective, the FTSE Aim index has risen by around 16 per cent in the same four-month period so 32Red shares have outperformed their benchmark index handsomely. They have also hit the 66p target price of brokerage Daniel Stewart which also coincided with my own conservative target price.
The latest spurt in the share price, which sent 32Red shares to a seven-year high, came after the company announced a three-year partnership with ITV Brand Extensions which will see one of the broadcaster's biggest brands, I'm a Celebrity... Get Me Out Of Here, feature as a slot machine game exclusively at 32Red.com. The slot game will be available for casino, poker and bingo players. This follows a deal with Channel 4 which secures 32Red the sponsorship of 'Late Night Film' on Film4. The 12-month partnership will see 32Red's branding feature around both the 11pm and 1am film every night of the week.
And only today, 32Red has announced that it will be sponsoring the new series of The Paul O’Grady Show on ITV. The show, which kicks off this evening at 5pm, will be sponsored by the company's bingo brand, 32redbingo.com.
Investment in these partnerships highlight the proactive approach of 32Red's management team in marketing the business and widening the potential net of new customers. To recap, the Gibraltar-based company operates eight websites including: casino site 32red.com; 32redpoker.com; 32redbingo.com; 32redmobile.com; and 32redbet.com, a sportsbetting website. It also has three other casino sites: nedplay.com, goldenlounge.com and dashcasino.com.
Efforts to date have certainly been working a treat as in the first half of this year the company’s casino revenues increased 14 per cent to £16.5m, total revenues hit a record of £19m and active casino accounts rose by a third to 42,500 customers after 32 Red recruited 17,500 new players. Importantly, acquisition costs for these new recruits have been kept in check at £159 per player, which is easily covered by a casino yield of almost £400 per player. Importantly, this momentum has shown little sign of waning either: in the first 10 weeks of the second half underlying revenues increased 27 per cent on the corresponding period in 2012.
Bumper cash generation underpins dividends
As I have repeatedly pointed out in my articles on gaming companies, this type of business is highly cash generative, which is good news for income seekers. I calculate that 32Red's pro-forma net cash is currently around £4.2m, or 5.9p a share, after adjusting for the 2.5p and 0.8p a share dividends banked.
Moreover, with analysts at Numis Securities' expecting full-year EPS to rise to 6.3p, up from 4.1p in 2012, there is ample scope for the full-year ‘normal’ dividend to be lifted from 1.4p a share last year to 1.82p as Numis predict. That implies a further 1p a share dividend to be announced alongside the final results. But with an anticipated total payout of 1.82p a share covered 3.5 times by forecast net earnings there is scope for an even greater increase.
Interestingly, analysts at Numis are pencilling in a dividend per shares of 2.2p in 2014, rising to 2.5p in 2015. On this basis, the prospective yield is 3.3 per cent, rising to 3.8 per cent. That's clearly attractive and would imply annual growth rate in the payout of 18 per cent over the next couple of years. That's not unrealistic either since Numis are pencilling in EPS of 7.6p and 9p for the next couple of years, implying annual earnings growth rate of almost 20 per cent. In other words, it is only sensible to expect the dividend to grow inline with earnings growth at the very least.
So, not only are 32Red’s shares lowly rated on around 10 times 2013 earnings estimates, but assuming revenues and profits grow as analysts expect, then the multiple is forecast to drop to 9 times next year's earnings and a modest seven times 2015 forecasts. But even those multiples don't do justice to the undervaluation since the company's cash pile is expected to grow to £6.5m (worth 9.2p a share) by the end of this year, rising to £10.2m (14.5p a share) in December 2014, and £14.6m (20.7p a share) by December 2015.
Those cash projections look sensible since they are based on 32Red growing revenues from £38.5m in the current financial year, to £44.4m in 2014 and £50m in 2015. On this basis, cash profits are expected to rise by 20 per cent in both those years, to £6m and £7.2m respectively, assuming stable profit margins of 13.5 per cent.
Or put it another way, if 32Red can maintain the momentum in the business, and there is little reason to suggest otherwise, then we are inline for total dividends of 4.7p a share over the next couple of years and for the cash pile to more than treble from 6p to over 20p a share by the end of 2015.
Low valuation
To put the valuation into some perspective, with 32Red shares priced on a bid price-offer price spread of 66p to 67p, then net of the aforementioned year-end cash pile estimates, the forward rating is only seven times next year's earnings, falling to a bargain-basement five times 2015 earnings forecasts. That rating is not only anomalous, but with 32Red likely to issue an upbeat outlook statement in late January ahead of its final results in March, there is an obvious catalyst for a further re-rating in the coming months.
In my opinion, a rating of around 10 times 2014 earnings estimates net of cash is more appropriate for this type of business. If achieved, this would imply a share price closer to 90p, or 36 per cent above the current price.
A higher rating is not only justified on fundamentals, but is well supported by the technical set-up too. The 14-day relative strength index (RSI) is not overly extended with a reading in the low 60s, the share price is trading marginally higher than its 20-day moving average (around 65p) and is not that overextended above its long-term 200-day moving average (around 55p). Furthermore, there isn’t much in the way of technical resistance until the price hits a range between 88p to 97p, dating back to 2006.
So, ahead of what is likely to be yet another upbeat trading update in January, and with scope for further cash returns, I am upgrading my target price from 66p to 90p. This is 10 per cent below Numis’ 100p a share target price. Trading buy.
■ Finally, as a pre-Christmas offer exclusive to Investors Chronicle readers, all telephone orders placed with YPDBooks for my new book Stock Picking for Profit will receive complimentary postage and packaging. This offer is strictly for a limited period, is subject to stock availability and applies to only telephone orders placed until Friday, 15 November 2013.
Please note the book is only being sold through YPDBooks and no other source. Full details of the content of the book is available online at www.ypdbooks.com. If you would like to take advantage of this offer, please contact YPDBooks on 01904 431 213 and quote reference 'ICOFFER'. The book is priced at £14.99. Internet orders will continue to incur the normal postage and packaging cost of £2.75. I have also published an article outlining the content of the book: 'Secrets to successful stock picking'.
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