Stockwatch: odds improving in favour of this former high roller

Is a turnaround at Rank Group (The) (LSE:RNK) worth backing?

Annual results to 30 June for this small-cap, casinos-to-bingo halls group show a recovery from the impacts of Covid and higher costs under inflation, also muted demand through the cost-of-living crisis.

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With consumer discretionary spending stocks lately under the cosh, gambling would hardly appear a dependable play. But as one veteran Ladbrokes’ shareholder told me some 15 years ago: never underestimate the British gambling spirit. Ladbrokes, I recall, was a frustrating stock, and story to divine, but well-timed shareholders did eventually benefit from a takeover.

Financial growth of 10% and better

Underlying operating profit at this largest UK operator of casinos and bingo has soared 131% to £46.5 million – albeit only slightly ahead of expectations – on net gaming revenue up 9% to £735 million.

Care is needed with the numbers given material adjustments involved, although reported operating profit of £29 million improves radically on a £110 million loss in 2023.

Of concern is how an £8 million impairment relates to casino/bingo operations which failed to meet expectations. Yes, you can see through this to consider the continuing operations’ performance, but such impairment is a cost weighing on the business quite differently from an amortisation charge near £7 million.

If we therefore apply this impairment charge to £27 million of adjusted net profit, Rank is left with £19 million net profit and earnings per share (EPS) of 4p instead of 6p – hence a trailing price/earnings (PE) multiple near 19x. This would still be fair rating currently, if the business is gaining vigour as described.

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When initially browsing through the report, it struck me how the new financial year has started well: net gaming revenue is up 10% in the first six weeks and against a strong comparator.

If recently published forecasts reflect guidance on separating out any future impairment, then targeting £32 million net profit in 2025 for EPS near 7p – hence a forward PE near 11x – is a bit rich. But if these adjustments are tailing off, Rank’s valuation starts to look attractive.

At 75p to buy currently, the stock also appeals in a long-term context: the five-year chart showing it has only just lately jumped off a 65p low earlier this month:

Source: TradingView. Past performance is not a guide to future performance.

That’s not too far off the late-2008 low at around 50p, from where the stock rallied to a peak of 300p by early 2016. It is tricky to assume much from the past now that plenty of online gambling sites have sprung up, but Rank has capability here too.

All operations – especially digital – are performing well

Grosvenor Casinos - the largest multi-channel casino operator in the UK - constitutes 45% of Rank’s annual “net gaming revenue” and 51% of its adjusted operating profit after this segment advanced 42% near £24 million. This side has improved from “the impact of lockdowns, slow return of international customers particularly to London casinos, and a tightening of affordability restrictions”. Such a trading context has coincided with strengthening the management – a new managing director and operations director – helping customer engagement scores rise.

The CEO is calling for a law change to attract more international “high rollers” to its London casinos, which have to force customers to write a cheque instead of use credit. Visitors from the Gulf are nowhere near earlier levels.

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Mecca Bingo at 19% of revenue has turned things around from a near £6 million loss to £4 million profit. Mecca has benefited from reducing the estate from 82 to 52 venues, chiefly driven by the pandemic albeit creating “a stronger and more competitive estate, higher visits and more attractive prize boards”. There seems a lot of customer churn however, given over 187,000 new memberships are cited - 44% of which are under 35 years old – yet only 1% growth in like-for-like customer numbers.

There is small Spanish operation, Enracha, constituting 5% of revenue albeit doing well at 21% of group profit.

While digital revenue rose 12%, its operating profit soared 79% to over £23 million as operational gearing kicked in. This affirms Rank’s competitive strength in digital, constituting 50% of last year’s profit. Management claims its digital cross-channel revenues outpace rivals due to an enhanced, proprietary technology platform – now also transferred to the cloud.

Moreover: “There are many technology developments in the roadmap over coming years to deliver a full cross-channel seamless experience and maximise this area of significant competitive advantage.”

Meanwhile, group central costs were kept in relative check, up 8% to £14 million.

The Rank Group - financial summary
Year to 30 Jun

Source: company accounts.

Locking in materially higher dividend yield

The proposed 0.85p a share dividend looks meagre relative to the 7p+ pre-Covid, but it is what the market expected in respect of the June 2025year, and Rank’s board intends to pay an interim dividend early next year. Mind that after a 20% dilutive share issue in November 2020, the pre-Covid payouts are no strict comparison, although payout capability is still notable as proof of a turnaround.

I estimate that if impairment charges tail off and genuine EPS trends towards 8p in the next two years, paying out half of that – assuming investment and debt reduction needs also fall – implies a dividend per share of around 4p, hence a yield above 5% for buyers currently at 75p.

Potential scope for such is shown by the latest cash flow statement, where cash from operations has soared 76% to £113 million. Currently, payout potential is limited by £48 million having been applied for investment and £60 million to financing – which did however include a net £14 million repayment of term loans.

Mind how intangibles constitute 132% of net assets

It is easy to assume from data tables that downside risk is checked by end-June net assets of £339 million, or 72p per share. Yet the balance sheet has £446 million of intangible assets.

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With only £44 million debt (excluding leases) and £22 million net cash despite £153 million leases, it is curious how the net interest charge has amounted to £12.7 million. At least interest rates look set to continue easing, though given UK services inflation I expect this to take time.

Other possible downside risks include a cash-strapped Labour government introducing some kind of exceptional profit tax on gaming companies – which are performing well in a UK industry context but contribute nothing to genuine gross domestic product. Labour might also be persuaded by the social welfare aspect of gambling addiction versus the libertarian argument people should be free to choose their vices.

Warrants ‘buy’ rating as an evolving turnaround

I would not expect Rank to become a genuine growth stock; my long-term experience of following this sector has involved too much volatile performance. Not only did Ladbrokes prove a frustration, but one also often had to engage in behavioural guessing as to when the proverbial “high rollers” would be visiting London and its casinos.

Mind how Rank has a 60% Malaysian shareholder, where such control can limit the stock rating but also adds long-term potential of takeover. GuoLine Capital Assets did raise its stake from 57% just over 60% last April.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.