Paddy Power (PAP) has been at the leading edge of the many technological changes that have propelled bookmaking from the high street to smartphones and the internet. Indeed, patient investors have been rewarded with a 12-fold increase in their capital over the past decade. However, there comes a point where growth starts to come at an ever higher cost. In Paddy Power's case, there are hints that having had the first mover advantage in gaining a strong online presence, this also means being the first to see its earnings growth moderate as its customer base matures, which seems to be reflected in the shares' recent underperformance of the sector and the wider market.
- Polished marketing machine
- Still an online leader
- Growth shows signs of slowing
- Marketing costs are mounting
- High rating
- Lacks retail scale
The recent interim management statement was a case in point. Revenue growth from the start of the year to 12 May slowed down substantially in some key areas. Take Australia, for example, which is arguably Paddy Power's single most lucrative market. The growth in online net revenue was of 28 per cent compared with 37 per cent in the same period last year. And overall net revenue growth of 20 per cent year-on-year was well down on the 28 per cent the previous year.
Indeed, broker Credit Suisse expects full-year sales growth in 2013 to come in at 12.7 per cent followed by 13.2 per cent the following year, compared with 30.9 per cent in 2012. EPS is expected to rise 13.2 per cent in 2013 followed by 15.5 per cent. That growth is impressive, but we think Paddy Power's bumper rating demands more. The shares' rating of 21.4 times Bloomberg consensus forecast earnings is close to a five-year high and well ahead of the five-year median average of about 17.2 times. It is also well above the share rating of peers such as William Hill on 15.1 times and Ladbrokes on 12.8 times.
There are variables that could cause the recent moderation in growth rates - the weather forcing the cancellation of sports events is a frequent problem for bookies. But there could also be first signs that the customers Paddy Power is adding to its books are not yielding as much as the enthusiastic gamblers who joined in the first rush. That's a problem because the cost of servicing an occasional punter, in terms of customer service and IT support, is just the same as for a high roller, so the yield per customer starts to come under pressure.
PADDY POWER | ||||
|---|---|---|---|---|
| ORD PRICE: | 6,490¢ | MARKET VALUE: | €3.2bn | |
| TOUCH: | 6,474-6,490¢ | 12M HIGH: | 7,133¢ | LOW:4,756¢ |
| DIVIDEND YIELD: | 2.4% | PE RATIO: | 20 | |
| NET ASSET VALUE: | 565¢ | NET CASH: | €153m* | |
| Year to 31 Dec | Turnover (€m) | Pre-tax profit (€m) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2010 | 427 | 111 | 193 | 75.0 |
| 2011 | 499 | 143 | 255 | 100 |
| 2012 | 654 | 139 | 251 | 120 |
| 2013** | 737 | 159 | 281 | 134 |
| 2014** | 834 | 186 | 325 | 155 |
| % change | +13 | +17 | +16 | +16 |
Normak market size: 500 Matched bargain trading Beta:0.53 *Excludes €56m of customer balances **Credit Suisse estimates, underlying PBT and EPS forecasts not comparable with prior periods | ||||
This afflicts most major bookies, but it is worrying that Paddy Power's costs are demonstrably spiralling ahead of revenue growth. In Paddy Power's case, 2012 results were particularly striking. Growth in net revenues (the company's win margin on all bets placed) was up by 25 per cent to €654m, but this was far outstripped by the rise in costs, which were up by 31 per cent to €417m. In contrast, in 2011 the ratio was perfectly balanced with both measures showing growth of 16 per cent. In short, the pressure to gain market share may now be taking its toll.
The other factor to consider is Paddy Power's relative lack of scale in the UK market with just over 209 shops in the UK against more than 2,400 for William Hill. It also faces the impact of a government machine gaming levy of 20 per cent coming into effect this year, and Paddy Power can expect to lose €2.2m of operating profit annually.
