ENT - Entain: Strong Earnings Growth Solid Cash Flow And Healthy Balance Sheet

Summary

• ENT reported high single-digit growth in online sales in Q4 2022 with increased win margins, higher online sports betting, and online gaming growth.
• The company increased FY22 EBITDA guidance, and the online growth was in line with expectations.
• I see a 27% upside to the stock. ENT is attractive due to its strong earnings growth, solid cash flow, and healthy balance sheet with a reasonable valuation.

Investment thesis

I see a 27% upside to Entain plc (GMVHF)(GMVHY) ("ENT") stock. In my opinion, ENT is attractive due to its strong earnings growth, solid cash flow, and healthy balance sheet. In terms of valuation, it's not ridiculously pricey either. Its multiple brand strategy increases its market access in these regions, and online should growth in the mid to high-single-digit percentage range in the coming to mid-term future.

Q4 22 earnings review

ENT reports high single-digit growth in online sales for the fourth quarter, with online sales up 8% on a constant currency basis. Higher win margins despite lower sports wagers contributed to a 7% increase in online sports betting in the fourth quarter, while online gaming grew by 10% on a constant currency basis. Fourth quarter NGR in Retail was up 9% in constant currency terms. In the fourth quarter as a whole, the group's revenue was up 7% on a constant currency basis.

Management increased FY22 EBITDA guidance from £925 million to £975 million to £985 million to £995 million. In summary, I believe that the online growth in Q4 is consistent with expectations based on previous management statements, although it is boosted by higher profits from sports betting.

Segments

The increase in online NGR was in line with projections made by management. Key factors that affected fourth-quarter performance were World Cup's , SuperSport's, Netherlands' relaunch delay, and adverse weather conditions. From a geographical standpoint:

1. The UK outperformed Q3 and continued to gain market share. Management boasted that their gaming and betting terminal offering was the best on the high street, which increased customer participation, traffic, and revenue. The company's efforts are geared toward expanding its market share and refining its gaming and racing terminals.
2. Australia maintained its upward trajectory with a robust fourth quarter that saw high-single-digits % NGR growth and additional market share gains.
3. Despite shaky macro conditions, Italy and Brazil are continuing their growth.
4. There is still a lot of work to be done in Germany due to the ineffective enforcement of regulations. While NGR was slightly lower in the fourth quarter, actives were higher. Management anticipates that FY23 will a growth year in Germany, assuming enforcement occurs in this period.
5. BetCity was finished in the Netherlands on January 23 and preparations for license issuance are well underway for the first quarter and second quarter of this year.

Margin

ENT was successful in achieving its desired contribution margin. For FY23, however, management is bracing for even greater stress from factors like Australia's planned POC tax increase and the usual pressure that surrounds product launches. Some of the things that can help with margin are sprinkled in amongst everything else. For instance, in the Netherlands, once the relaunch is complete, they anticipate breaking even within 9 months. Taxes in Brazil shouldn't be a major concern, as they'd be more than countered by other benefits, especially as NGR continues to rise. Regulation in Germany is not anticipated to have a major impact on the country's contribution margin. Long-term, 40% should still be the goal, and the higher contribution margin observed during COVID is certainly achievable.

Growth in new markets

During FY22, ENT has made a soft launch in two markets (in Brazil and outside of Ontario). I think it's smart to see if these markets are actually sustainable by conducting some preliminary testing. Rather than immediately investing more money into advertising, I think it's best to play the long game here. In FY23, the company plans to use its newfound knowledge to enter additional markets. In general, I find it encouraging that upper management is thinking so far ahead. However, I wouldn't put too much stock in this as a revenue and valuation driver in the near future.

Some thoughts on UK white paper

The UK's NGR growth was nearly flat in 2H22, when it should have been in the mid- to high-single digits. If taken at face value, this suggests that the new restrictions will add 10% inefficiency. My assessment is that the effects of the new measures will have faded by the end of H1, so H2 will be more successful than H1 barring any unforeseen events. However, I believe management is being cautious about FY23 outlook until more information is available. One thing to note is that the DCMS's most recent comments were quite pro-industry.

Capital allocation

Management remains active on the M&A front. I do think a strategic fit is necessary, though. M&A should help the ENT industry expand into new markets or thrive in the ones it already occupies. The strength of ENT's business strategy and cash flow should help this along. Regarding valuation, I agree with management's strategy not to acquire a troubled asset but rather a robust enterprise.

Guidance

The midpoint of the expected range for EBITDA in FY22 has been increased by 4% to a range of £985 million to £995 million. The main factors that led to the upgraded guidance were Online performance in line with expectations, Retail outperformance, postponing investment in new opportunities until FY23, and the contribution from SuperSport.

Valuation

While revenue did as expected this quarter, EBITDA was better than I expected, especially with a raised guidance for FY22 EBITDA (higher base for future numbers). Using consensus estimates and a normalized forward P/E (15x), I believe the upside from here is around 27%.

Model walkthrough:

1. Revenue is expected to meet FY22 guidance, then slowly converge to a normalized growth level of mid-single digits.
2. EBITDA margins should continue to improve as ENT continue to execute well and hit its contribution margin target.
3. Valuation should trade down to a more normalized level moving forward.

Conclusion

In conclusion, I believe that ENT's stock has a 27% upside potential. ENT is attractive due to its strong earnings growth, good cash flow, and solid balance sheet. The company's multiple brand strategy enhances its market access and its online growth is expected to be in the mid to high single-digit range in the near future. ENT's performance in different regions varied, with the UK outperforming and Australia maintaining its upward trajectory, while Germany still has work to do. The company is also looking to maintain its contribution margin and is exploring new markets with a soft launch in two regions. Management is also actively looking for M&A opportunities for growth and has a strategy to acquire a robust enterprise.

Guidance wise, the expected range for EBITDA in FY22 has been increased to a range of £985 million to £995 million due to online performance, retail outperformance, postponed investments, and contribution from SuperSport.

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