Tsogo Sun Gaming beating the odds

You should never waste a good crisis, to paraphase Winston Churchill, and indeed many well-run listed companies have emerged from the past two years of pandemic-induced misery in much better positions.

Not only did they use this period for deep efficiency gains (cost cutting) that have boosted their margins, but many weaker, worse-run competitors likely went out of business, giving the survivors market share gains.

Tsogo Sun Gaming (TSG) is an excellent example of this.

While Sun International (SUI) – with the astute backing of Value Capital Partners – is doing a good job of turning its ship around, Tsogo Sun Gaming was already an efficiently-run, best-of-breed casino group pre-Covid.

Yet Tsogo Sun Gaming’s H1:2023 results out last week show that this perception was only relative to peers and not necessarily an absolute fact …

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If we compare Tsogo Sun Gaming’s latest half-year to its H1:2020 results (importantly, the six months ending September 2019 was pre-Covid), revenue has not fully recovered and is still negative 8%.

If we assume that there was cumulative inflation of about 16% across this period, then revenue still has over 24% more to recover to get to pre-Covid levels.

And that is the only bad news.

Double-digit decline in operating costs

H1:2023’s operating costs are down 12% versus pre-Covid levels. But there has been inflation here too. In real terms (excluding inflation), Tsogo Sun Gaming’s operating costs are actually down by a whopping 28%.

This waterfalls through the group’s income statement as its Ebitda (earnings before interest, taxes, depreciation, and amortisation) margin has risen to 35.6% from 33.2% pre-Covid and, excluding the once-off separation fee paid to Southern Sun Hotels, this translates into headline earnings per share (Heps) that is 30% higher than pre-Covid levels.

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Imagine how much higher Tsogo Gaming’s profits would be if its revenue was back at pre-Covid levels …

While there are plenty of variable costs in the group (these are costs that increase as revenue increases), the majority of the costs associated with running casinos are pretty fixed, including buildings, machines, tables, staff and licences.

If we assume that about a quarter of Tsogo Sun Gaming’s operating expenses are variable, then if revenue was 24% higher for Tsogo Sun Gaming (in line with pre-Covid plus inflation), I estimate that its Heps would have been nearly double that reported in H1:2023 – and nearly one-and-a-half times more than its pre-Covid Heps.

Tsogo Sun Gaming has certainly not wasted this crisis and I take my hat off the management here. They have done a sterling job under the circumstances.

If we annualise its H1:2023 Heps (excluding the Southern Sun once-off), Tsogo Sun Gaming is trading on a price-earnings (PE) multiple of around 7.7 times.

Going one theoretical step further and working out my hypothetical ‘normalised’ earnings (keeping the efficiency gains while normalising revenue to pre-Covid nominals), I estimate that the share may be trading at a PE of as low as around four times.

They say ‘the house always wins’, but over the pandemic I think the opposite happened. That said, ‘the house’ has certainly put in a lot of blood, sweat and tears to come out of this nightmarish period stronger. Well done to them.

* Keith McLachlan is chief investment officer at Integral Asset Management.