At Valuecruncher we have always been a fan of the business model of New Zealand-listed gaming, hotel and entertainment company Sky City (SKC.NZ).  They have a legal monopoly in key parts of the New Zealand market offering gaming with games structured to favour the house.  All businesses should be so lucky.  The SKC.NZ share price has moved in a range between NZ$5.50 and NZ$2.91 over the last year.  The current share price is NZ$3.30.  How is this in relation to the intrinsic value?

Valuecruncher valuation model of SKC.NZ with interactive assumptions

Valuecruncher produces a valuation of NZ$3.51 for SKC.NZ. This is a current valuation (an estimate of intrinsic value using a discounted cash flow model) not a target price. This valuation is 6.4% above the current share price of NZ$3.30.

Assumptions

• Revenue: Reuters aggregates eight analysts covering SKC.NZ and these analysts have mean estimates of 2009 and 2010 revenues of NZ$853.3 million and NZ$888.3 million respectively. For our analysis we have used NZ$850.0 million in 2009, NZ$885 million in 2010 and NZ$915 million in 2011.
• Profitability: We have used an EBITDA margin of 35% in 2009 rising to 36% in 2011. Reuters has SKC.NZ‘s EBITD margin at 29.6% last year and an average of 36.8% over the last five-years.
• Capital Expenditure: We have assumed capital expenditures of NZ$90.0 million in 2009 then NZ$75 million moving forward.
• Discount Rate: 10.0%. The PwC New Zealand cost of capital report has SKC.NZ at a WACC of 10.8% with the wider NZ market at 9.5%. We feel that 10.8% is too high. We believe there is an argument for a discount rate anywhere in the 8-10% range for SKC.NZ.
• Terminal Growth Rate: 3.0%. The New Zealand economy has grown at an average rate of 2.6% over the last five-years. We see SKC.NZ growing broadly in-line with this moving forward.

Our analysis incorporates the cash and debt the SKC.NZ balance sheet – Valuecruncher calculates a net debt number.

Play with our assumptions – what does your analysis say?

Disclosure: None

Valuecruncher has valued each Sky City share at $5.10, with a range of $4.13 to $6.13. The share price closed at $4.85 on the 28th of February down 23 cents following the announcement of the interim results for the 6 months to December 31. 

Revenue Growth 

Revenue growth is forecast to decline steadily at 9%, 7% and 5% for 2006/07, 2007/08 and 2008/09 respectively, converging to the terminal growth rate of 3%. The declining revenue growth projections reflect the limited opportunities Sky City has to expand gaming operations in New Zealand. 

EBIT Margins 

Sky City’s result for the 6 months to December 31 revealed an after tax profit of $45 million down 23.2% on the same period a year ago. A key contributor to the lower profit was adverse VIP/commission outcomes (theoretical returns on revenue gambled) for the period. Expected profit margins are based on achieving the theoretical returns on revenue gambled, in the long run these theoretical predictions hold but in the short term returns can be volatile. The adverse VIP/commission outcomes for the 6 months to 31 December are incorporated in the forecast EBIT margin of 29% for the 2006/07 year. A conservative EBIT margin of 32.0% is forecast from 2007/08 onwards based historic levels. 

Discount Rate (WACC) 

The WACC used for this analysis is 10%. 

Terminal Growth 

Terminal growth has been set at 3%.  

Sky City Valuation             

Valuecruncher has valued each Sky City share at $5.42, with a range of $4.41 to $6.51. The current share price is $5.03, close to the mid point valuation of Valuecruncher.

Revenue Growth

Revenue growth for the past few years has been –7.34% (03/04), 18.9% (04/05) and 11.3% (05/06). We believe that this growth will slow, as Sky City has just completed its first 10-year period, it will experience slower future revenue and earnings growth. We have forecasted the growth for the next 3 periods to decline steadily at 10%, 9%, and 8%, mowing towards terminal growth of 3%.

EBIT Margins

EBIT margins have been relatively stable at 36.5%, 32.0%, 33.3% and 32.4%. To be on the conservative side of valuation, 32% EBIT margins have been used for the next 3 years.

Discount Rate (WACC)

The WACC used for this analysis is 10%.

Terminal Growth

Terminal growth has been set at 3%, following the historical long-term growth rate.

Sky City Valuation