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Date : 28/11/2022

The Lottery Corporation

ASX :

TLC

Market Cap : $10.10 Billion

Buy

52 Week Range : $4.47 - $4.57

Share Price : $4.54

A monopoly in the lottery business that brings in steady profits. We recommend a 'Buy'.

Company Analysis

The Lottery Corporation (ASX: TLC) spun out of Tabcorp in May 2022, instantly becoming an ASX-200 company with an $11 billion market capitalisation. It is one of the simplest but most efficient businesses on the ASX. TLC is Australia’s leading lottery and Keno games company and one of the best-performing lottery businesses in the world. They operate a diversified and balanced portfolio of high-profile brands under exclusive and long-dated licences and approvals.

People buy lottery tickets with the hope of winning weekly cash prizes. The more people that buy the tickets, the more money TLC generates. The Lottery Corporation is as simple as that; hence, it is a very efficient and scalable business model.

TLC has over 8.3 million active customers as of FY22. This is equivalent to 46% of Australia’s adult population. They operate through 7,200 retail points of distribution, as well as digitally. It is one of Australia’s largest retail franchise networks, selling 660 million lottery entries in FY22.

The Lottery Corporation has infrastructure-like and defensive asset qualities, increasing profitability, significant and diverse retail distribution, and upside potential from digital growth.


Source: Tradingview.com

3 Qualities that make TLC a great Stock to Own

Monopoly in the Aussie Lottery Industry

The Australian lottery industry is licensed and regulated at a State and Territory level, with State regulators overseeing compliance with legislation, rules and regulation relating to the lottery games. The Lottery Corporation maintains exclusive and long-dated licences or authorities to operate in all States and Territories excluding Western Australia. This means that except for WA, TLC or its agents is the only way Aussies can buy lottery tickets; hence, the company is essentially a monopoly that generates fat stacks of cash.

Coming to the other segment, Keno is licensed and regulated at a State and Territory level, with licensed/authorised operators supplying Keno in venues such as hotels, clubs, wagering agencies and casinos. The Lottery Corporation has licences or authorities to operate Keno in venues in New South Wales, Victoria, Queensland, South Australia, and the Australian Capital Territory.

As part of its approvals received to conduct Keno in the Australian Capital Territory and Victoria, The Lottery Corporation is also approved to operate an online Keno platform. The remaining jurisdictional licences in Tasmania, Western Australia and the Northern Territory are held by other operators. These operators have arrangements in place with The Lottery Corporation, which allow them to utilise The Lottery Corporation’s Keno systems.

TLC is a leader in the lottery and Keno markets and operates a diversified offering across multiple products. Customers thus have nowhere else to go, and TLC is taking full advantage by offering various lottery games.

The picture below shows the years of maturity for State-wide licenses that TLC holds. The company’s licences and approvals are long-standing and unlikely to expire soon. Hence, it is safe to say that TLC is a monopoly and operates on a significant scale, not to mention that it caters to 46% of the Australian adult population.

Sweet Dreams in Hard Times Add to Lottery Sales

Considering the bigger economic picture, the kicker is that TLC has historically done well during economic downturns. Research shows that when times are tough, such as when unemployment rises (which is expected to), lottery sales increase slightly, suggesting that some people see the lottery as a solution to financial hardship and spend money on it when they can least afford it. This makes TLC a rare counter-cyclical stock.

The lottery business has for decades performed well through recessions, and the prospect of inflation hitting discretionary spending – including gambling – has not been a problem. Looking back in history, TLC has proven to drive sustainable revenue growth, even during downturns such as through the GFC and other challenging economic cycles through COVID. The company has seen an acceleration of interest in its products.

As inflation continues to bite households and interest rate hikes reduce discretionary spending, we expect a surge in lottery ticket sales, just as it has been the case in past economic cycles. It is also worth noting that lottery ticket purchases are habit-forming and captives customers into regular purchases.

TLC’s Digital Push will Improve Profitability

Australia’s aging population buy lottery tickets from brick-and-mortar outlets. TLC has 7,200+ retail points of distribution. Despite lockdowns, lottery ticket sales were high as TLC’s agents were not significantly impacted. TLC has this subset of its customer base sorted.

Now, the company is going after the younger generation by introducing digital avenues to purchase lottery tickets. As a bonus, it gives the older generation another medium to quickly purchase lottery tickets.

To sum up, TLC is a monopoly, and they have an incredible retail presence that caters to 46% of the Australian population. In a quest to grow, the company is expanding digitally to attract and cater to younger Australians – a subset favouring online transaction. Add to this the fact that lottery ticket sales have historically been counter-cyclical, and we are now in a period where inflation and interest rate hikes are biting into Aussie households; TLC is well positioned.

Company Updates

A Simple Corporate Strategy that is Aligned to Drive Growth

TLC’s growth strategy is underpinned by a customer-led focus on product innovation, deepened engagement across all channels, and digital expansion. The management team and Board are continuing to refine the company’s growth strategy, which will position the company to increase its already high revenues and profitability.

  1. Innovate game portfolio

Over the past 11 years, The Lottery Corporation’s businesses have successfully implemented 14 game initiatives. TLC intends to continue optimising and refreshing its game portfolio to align with changing player motivations, maximising relevance, and reach. They have significant in-house expertise and international partnerships that keep the innovation pipeline long.

  1. Pursue licence and other opportunities

The company is exploring opportunities for enhancements to existing licences and selectively evaluating potential future new licence opportunities (domestically and internationally) as and when they arise. The company has made it open knowledge that it may consider other acquisition and commercial transaction opportunities as and when they arise. This brings a lot of potential as we can see TLC move into a different market and bring in lots of earnings potential.

  1. Enhance customer experience

TLC is innovating tailored customer experiences further to drive engagement across all channels. Upcoming planned enhancements include introducing more omnichannel Keno offerings (including new retail digital hardware), new payment options, digital capability upgrades and contact centre transformation. TLC plans to complement this with data-driven personalised marketing, such as one-to-one and cross-channel personalisation.

  1. Evolve retail footprint

TLC recognises that its customers’ purchasing behaviours continue to change and is further diversifying its retail channel mix through targeted growth in selected channels such as convenience fuel, convenience, and pharmacy. Like Keno, TLC plans to invest in Lotteries’ retail hardware and the integration of digital features, which is expected to strengthen the Lotteries’ omnichannel offering.

  1. Strong industry and regulatory engagement

The firm already has deep relationships with regulators and industry stakeholders and works collaboratively with its partners to help shape the future industry and regulatory landscape. In addition to its domestic presence, TLC has a strong standing and profile within the global lottery industry and is represented at the World Lottery Association and Asia Pacific Lottery Association executive level. This is a handy advantage, especially when expanding to new geographies is on the cards for the company.

Top Institutions among TLC Ownership

In September, Vanguard Group purchased 7.7 million shares in TLC at an approximate price of $4.74 apiece.

Top Shareholders are big funds. Institutional investors clearly like TLC: 9.39%, 6.75%, 5.56%, and 5.07%, are owned by AustralianSuper Pty. Ltd., State Street Global Advisors, Inc., BlackRock, Inc., and The Vanguard Group, Inc., respectively.

Investment Thesis

There were two overarching priorities for the year: delivering the demerger and maintaining momentum in the business. In its first financial report since the demerger, TLC announced a very positive FY22 performance. It was a record result following a strong FY21 (supported by increased buying of lottery products during COVID-19 restrictions and lockdowns) and showed the value of the balanced game portfolio. Highlights include:

  • Comparable Group Revenue of $3,507m, up 9.4% on pcp (Reported Group Revenue: $3,279m)
  • Comparable Group EBITDA of $694m, up 11.9% on pcp (Reported2 Group EBITDA: $610m)
  • Group NPAT was $346.6m. Group NPAT before significant items was $373.2m, up 14.9% on the previous year.

The result shows the business’ resilience, defensive qualities, and omnichannel model benefits. The operating result overwhelmingly relates to the Lotteries business, as it only includes Keno results for the period of ownership between May 2022 and 30 June 2022.

In FY22, TLC sold over 660 million Lottery entries and delivered initiatives to enhance the customer experience. These included the Oz Lotto game change implemented in May that will deliver bigger prizes and more winners and enhancements to the responsible play programs.

The Lottery Corporation’s operations generated $1.7bn in lottery and Keno taxes for governments and more than $500m in commissions for newsagents, licensed venues and other retail partners.

Lotteries Segment

Strong revenue growth was underpinned by an active portfolio, jackpot sequence management, and digital growth. Favourable Powerball outcomes in FY22, good performance from base games.

Lotteries’ strong revenue growth was driven by the successful management of the jackpot games in the portfolio (jackpot games turnover up 22.8%), as well as the continuing shift to digital, which drove margin improvement. A lift in the digital share of Lotteries’ turnover (from 32.8% to 37.7%) drove further margin improvement.


Source: TLC

Powerball benefited from a favourable jackpot run with 13 jackpots of $50m or above versus seven in the pcp. The strength of Powerball’s performance through effective management of the jackpot sequence was evident in the turnover for the $120m jackpot in February 2022, which outsold the $150m draw in September 2019.

The overall performance of the base games was good, considering the particularly strong FY21, with turnover down 1.7%. Notably, Saturday Lotto and Set for Life consolidated gains from the prior period and recent game changes.

The lotteries retail network was largely unaffected by COVID-19 restrictions and closures and remained resilient, with turnover up 1.8% on the pcp. Digital turnover grew 25.8% and accounted for 37.7% of all lotteries’ turnover. This is improving margins.

Active registered customers grew 8.7% to 4.1m, with continued growth in customers who purchased tickets in both digital and retail channels. A game change to Oz Lotto was implemented on 17 May 2022. The change is designed to deliver bigger wins and more prizes in line with player motivations, with early signs encouraging and in line with expectations.

Keno Segment

The Keno business was acquired in May 2022 from the Tabcorp Group as part of the restructuring required to effect the demerger. For June 2022, the reported revenue for the Keno business was $23.7 million, and EBIT was $6.5m.

On a Comparable basis, Keno delivered revenue of $252.4m, down 0.9% on the pcp and EBITDA of $93.0m, down 4.9% on the pcp. Keno’s performance was largely in line with FY21 despite the impact of 16 weeks of COVID-19 venue closures in NSW in FY22. The result was supported by strong digital performance, while the retail channel rebounded strongly once COVID-19 restrictions were eased.

NSW is Keno’s largest market, where current licence conditions and regulations do not allow digital sales. Keno benefited from digital turnover growth of 14.6% in other states and improved retail performance in Queensland and Victoria. Innovations, including a digitally enhanced retail experience with digitised tickets and real-time win notifications, were launched during FY22.

In April 2022, The Lottery Corporation secured a new 20-year Victorian Keno licence on a non-exclusive basis, which runs through to 2042 and allows for digital distribution in Victoria for the first time.

Outlook & Valuation – Further Margin Improvement Expected

During FY22, there was margin improvement from the continued lift in digital share of turnover (up from 32.8% to 37.7%). Turning to FY23, Regarding draw game enhancements, TLC had initially planned for Monday & Wednesday Lotto to be their major game change this year. That’s now intended for FY24, and the company has brought forward its plans on Powerball, TLC’s largest jackpot game. TLC is looking to increase the subscription price toward the end of FY23 – from $1.10 to $1.20 per game. This would be the first change to Powerball’s subscription price in five years. Powerball is also the largest contributor to TLC’s revenues, and a $0.10 change should boost revenue. It would also reinforce Powerball’s position as the premier jackpot game.

TLC is also reviewing the omnichannel commission structure for its retailers, including the base commission rate. While we still await further information regarding this, the increased digitisation will ensure TLC has better margins. As the uptake of digital lottery tickets increases, the company should then be able to leverage its position and force the commission rate lower.

TLC is a very efficient business. Given the counter-cyclical nature of the business and other tailwinds propelling the lottery industry, we expect TLC to continue growing its revenues. In FY23, the revenues from the Keno business will take effect for the entire year. We expect this segment to add about $350 million to overall revenues. Additionally, revenues from the lottery business should continue to expand at an average of 3% year-on-year. TLC maintains healthy earnings margins, and we expect this to continue going forward. Estimates suggest that EBITDA margins of around 20% will be maintained.

Considering the consensus valuations, TLC is trading at an FY23 P/E of 28.7x. TLC shares are priced very similarly to Tabcorp, which also trades at a P/E of 27x for FY23. However, we expect Tabcorp to offer relatively better revenue growth. Given the digitisation improvements, we expect profitability to increase quicker than the market currently anticipates.

Balance Sheet shows high Debt, but there is No Danger

Perhaps the only negative aspect of TLC is its balance sheet strength. TLC has $543 million in cash and over $2.4 billion in debt on its balance sheet and maintains gearing at 3.1x Net Debt/EBITDA. While this is on the higher end, TLC is not too concerned about it due to the nature of the business. The debt arises due to prize liabilities and customer account balances. The firm thus targets gearing in the 3.5x – 4.0x range.

The debt profile shows average maturity of 7.2 years, and no debt will be called in the next couple of years. Additionally, TLC has already set up facilities with long-dated USPP debt to provide core long-term funding. There were $570m of undrawn bank facilities at year-end, and the interest rate is fixed on 83% of the gross debt.

The Lottery Corporation does not pay a dividend right now. However, the company is expected to pay its inaugural dividend during the interim FY23.


Source: TLC

FY23 off to a Positive Start

At its AGM, TLC provided a trading update for the first 4 months of the financial year. Group revenue was up 11% on the pcp, with Lotteries up 9% and Keno up 33%. It’s a healthy result, and evidence of continued momentum is supported by the strategic actions TLC has taken to drive performance across all its games.

Looking at Lotteries, TLC reported seeing strong customer support for the games. All their base games remain resilient and an important foundation for delivering sustainable revenue growth.

Jackpot games are performing well with strong customer support at the various draw levels and active management of the jackpot sequences driving a record jackpot offer on our Powerball game in October.

TLC had a slow start to the year in terms of jackpot activity, but that took a positive turn in recent weeks as Powerball rolled through to a $160 million jackpot and delivered another record turnover result. Powerball’s mass appeal was again on display, with the draw attracting 135,000 new registered players and customers queuing for their tickets in retail outlets. At peak times – roughly three hours before the draw – TLC sold 8,700 games per minute to Australians.

Retail continues to generate most of the Lottery turnover, and there is continued growth in digital, which made up 39% of total volumes.

On Keno, the strong return to growth was predominantly driven by venues trading without the restrictions in NSW, Victoria and the ACT that negatively affected the prior period. There has also been strong performance in Queensland, with turnover up 18%.

Recommendation

The Lottery Corporation is a monopoly – the only way Australians outside WA can play lottery games. They cater to 46% of the population, mainly the ageing Aussie population. TLC is now pushing to extend their presence to the younger generation by instilling digital infrastructure – allowing players to buy lottery tickets on their phones, which is the preferred medium of the younger generation. The digital push is going well, and more players are adopting it, resulting in improved profit margins. This is central to TLC’s corporate strategy, among a host of other strategies that will see revenues grow and margins extend. TLC is a well-managed business, and the Board is expected to also pay dividends in March 2023. With predictable and stable revenues, improving profits, and initiation of dividends, we recommend investors to ‘Buy‘.

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