TRADE OF THE MONTH

Distell’s looking bubbly, but patience is needed for Sun International

“Casinos will take longer than expected to resume normal trading patterns, and Sun might need to rely on Sun Slots for a quicker recovery

Sin stocks were severely punished in the various Covid-19 lockdowns. By “sin” stocks IM is referring to companies that rely on addictive vices to churn revenue and cash flows — such as liquor, tobacco and gaming counters.

Traditionally — thanks to unalterable human nature — these “sin” companies have been reliable cash flow generators and solid dividend payers. People will smoke, people will gamble and people will drink. Fact.

Of course, the business model does face stern challenges when the government enforces a lengthy shutdown with a disturbingly puritanical vigour. The model creaks dangerously when debt has to be serviced but cash flows are stanched by events out of management’s hands.

This month IM looks at two staple sin stocks — liquor group Distell and gaming group Sun International.

Both companies took strain in the lockdowns, with lengthy bans on large social gatherings and on the sale of alcohol.

Both are poised for a comeback once the pandemic recedes — but IM reckons the recovery in the respective companies will unfold at a different pace.

At this delicate juncture, IM would back Distell for a sharper short-term recovery and prefer to be short Sun for the next few months. IM is not doubting Sun’s eventual turnaround, but simply believes it will take longer for trading to recover fully in the larger urban casinos.

Distell’s recent trading update for the six months to end-December was bubblier than expected for a business that had seen the trading period in its largest market (SA) reduced by 22%. Headline earnings should come in above 600c a share, probably close to 625c a share.

At the best of times it’s not prudent to annualise Distell’s earnings and doubly so now, given that a full month of trading was lost in January and the distinct possibility of meaningful excise duty hikes. But IM would be surprised if the group — provided there is no prolonged and restrictive “third wave” lockdown — cannot post a similar performance in the second half.

What investors are now seeing is that the strength of Distell’s brands, its agility and previous investments in route to market, as well as the optimisation of its production network, are paying off — especially in markets outside SA.

Significantly, Distell’s foreign-based revenues increased by double digits. With more than 40 days lost in local trading, it speaks volumes for the strength of Distell’s bestselling brands — like Savanna, Hunter’s, 4th Street and Klipdrift — that the business achieved almost flat revenues on a 1.4% volume decline. Stockpiling much, local tipplers?

The biggest takeout from the trading update was the disclosure that Distell recorded an impressive performance in its African markets (Kenya and Mozambique being the standouts) with revenues and volume surging by about 20%.

What’s more, Distell’s international business performed strongly across all markets, with a more than 15% jump in revenue and, more importantly, “significant margin improvement as the business capitalises on its premium whisky brands, improved online sales channels and historical investments in aged stock”.

There was further reassurance on the balance sheet with

Distell reporting that the SA net debt to earnings before interest, tax, depreciation and amortisation covenant ratcheted down to around 1.2 times compared with 3.1 times at end-June last year.

Sun still has strenuous work ahead in deleveraging its balance sheet, even after the sizeable R1.2bn rights issue.

Sun is exiting its Latin American operations and has sold off the casino licence at the Carousel. Whether other small casinos will be sold remains to be seen.

The trouble for Sun is that its new mega casino, Time Square in Pretoria, was just starting to find traction when the lockdown disrupted trading. Much of Sun’s recovery depends on Time Square justifying its R4bn development cost, which is difficult in this trading environment and when the consumer is under considerable pressure.

IM reckons casinos will take longer than expected to resume normal trading patterns, and Sun might need to rely on its limited-payout machine subsidiary, Sun Slots, for a quicker recovery to post-Covid profitability.

Sun’s shares have rallied hard recently — shifting up about 30% since the start of the year. The full-year results to end-December, which should be released shortly, might induce some circumspection from punters around the timeframe for Sun’s turnaround.

Restricted trading hours and reduced trading space (due to social distancing) would have cut into revenue, and the alcohol ban would have dampened the mood around the tables.

What might also be sobering is the intensity of competition in the key Gauteng market, where larger rival Tsogo Sun has made plain its determination to maintain (and advance) its market share. ●