by Jalpa Bhoolia
Sun International develops, invests in and manages properties in the gaming and hospitality industry. Sun International's operations include resorts, luxury hotels and casinos in South Africa (SA), Zambia, Botswana, Namibia, Lesotho, Nigeria, and Eswatini. Locally, the group's best-known operation is the Sun City resort, and its gaming interests include prominent casinos such as Time Square, Grand West Casino, Carnival City, and the Wild Coast Sun.
In December 2023, Sun International announced the acquisition of Peermont Holdings for R3.2 billion. The purchase price is based on an enterprise value (EV) of R7.3 billion, less net debt and certain transaction costs, and is subject to capital expenditure and working capital adjustments.
Peermont is a leading hospitality and entertainment group of companies that operates 11 properties located across South Africa and Botswana, in addition to the online sportsbook, PalaceBet. Collectively, the group's physical properties offer 3 349 slot machines, 152 gaming tables and 1 636 hotel rooms.
The global hospitality industry
It goes without saying that the disruptive impact of the Covid-19 pandemic was far and wide. The hospitality and tourism sector, normally a vibrant and thriving industry, faced numerous challenges related to travel restrictions, social distancing, and generally downbeat consumer confidence. The road to recovery has since been a long and challenging one, but encouraging, nonetheless.
Per the World Travel and Tourism Council (WTTC), in 2023, travel and tourism's direct contribution to gross domestic product (GDP) globally was approximately $9.9 trillion or 9.1% of total global GDP. This is expected to grow in 2024 and beyond, constituting 11.4% of global GDP in 2034. This is beyond the contribution prior to Covid-19 and highlights that the sector is expected to grow more than average industry growth over the next decade.
According to a report from the Business Research Company, the global hospitality industry is expected to grow at a compound annual growth rate (CAGR) of 6.8% from 2023 to 2024, thereafter growing at a CAGR of 5.5%. Growth is expected to be fuelled by a confluence of factors: such as growing travel demand, disposable income relief, technological advancements and the growing integration of artificial intelligence, social media influence, and a robust resurgence in both business and leisure travel.
The South African landscape
Following the widespread standstill brought about by the pandemic, SA is still en route to a full recovery. Travel and Tourism in SA takes on a vital role for the economy, with the contribution to GDP from travel and tourism at ~7% pre-pandemic and dropping to a low of ~3% in 2020 and 2021, according to Statista. As the industry continues to recover, an annual growth rate of 5.9% is expected through 2029.
While tourism and hospitality are one facet for the Sun International group (Urban Casinos: ~55% of revenue; Resorts and hotels: ~25% of revenue), gambling is another major element. Casinos were scaled down during the pandemic and many gamblers turned to online betting. Sun International's online platform, SunBet, continues to soar, while the recovery in Casinos has been slightly bumpier. Nevertheless, we do believe that there is still scope for growth within this space, and that Sun International's refreshed positioncertainly provides an upper hand. SunBet accounts for just under 10% of revenue, while Casinos makes up ~55% of revenue, although we think that SunBet may hold a heavier weighting over time.
Financial performance and forecasts
The addition of Peermont will enhance Sun International's gaming offering - Sun International holds a strong market leadership position in the gaming arena and Peermont is certainly a complementary addition with the timing of the deal, in the context of an easing macro environment, acting as a tailwind. We think that the continued recovery in tourism in SA will be a driving factor for Sun International's growth trajectory over the forecast horizon. Tapering inflation, lower interest rates and improved consumer confidence will certainly alleviate some pressure on consumer disposal income, in turn boosting leisure spend. Qualitatively, we think that positive political developments may also favour growth prospects - the Government of National Unity developments earlier this year were broadly encouraging, and we saw the rand revive a touch against the US dollar. SA has recently crossed over 200 days without load-shedding, which is quite the milestone and another positive driver. Peermont attributes ~80% of total revenue to gaming, which is significant. Post Post-implementation, we expect Peermont to account for ~20% of total group revenue.
The purchase will be funded by debt and will see Sun International's SA debt levels increasing to ~R13.2 billion (June 2023: R5.9 billion). Sun International has historically paid off debt relatively quickly and managed gearing levels quite well. The group expects net gearing to increase to ~2.6 times EBITDA following the implementation of the acquisition, after which it expects to de-gear to levels lower than 2 times with 24 months to 36 months. During this time, a reduced dividend pay-out ratio of 50% is likely when the net debt to EBITDA ratio is above 2 times, while a dividend payout ratio of 75% is expected when the net debt to EBITDA ratio is below 2 times. Additionally, the group may consider disposing of the small casinos to alleviate some pressure on the balance sheet. We expect Sun International to make meaningful progress towards repaying debt and for dividends to be impacted for a short period.
We regard the balance sheet as steady even when considering the additional acquisition debt. In Sun International's latest batch of results for the half-year ended 30 June 2024, South African debt (excluding IFRS 16 lease liabilities) was R5.4 billion, down from R5.7 billion at the end of FY23 - this is testament to the group's ability to manage gearing effectively while maintaining a comfortable liquidity buffer.
What we like about this company
What we don't like about this company
Valuation
Consensus is positive on the stock with analysts predicting a 33% return on the stock over the next 12 months.
We utilised several valuation models with the most bearish outcome emanating from the Residual Income Model and the most bullish from our Free Cash Flow to Equity model. We calculate a fair value of R58.33, 29% above the current share price of R45.20.
The Peermont deal is expected to be transformative for the business. As noted above, however, there is significant execution risk attached to finalising, financing, and embedding the acquisition, which could explain the current discount the company is trading at relative to our calculated fair value.
