The year-end entries for the Jamaica Stock Exchange's Market Research Competition analysed the half-year/second-quarter performance of stock market companies. Najja Daley, financial analyst of Scotia DBG Investments, was selected winner from among six entries by the Dr Claremont Kirton-led panel of judges at the review of the entries on January 28, 2011. Daley scored 78 points to gain the advantage over a formidable field. Second place went to Mario Ahjahorie, 77 points, and third to Stacy-Ann Tait, who scored 74. Here is Daley's analysis, excerpted for space.
Supreme Ventures Limited (SVL) is a limited liability company incorporated in Jamaica and listed on the stock exchanges of Jamaica and Trinidad and Tobago. The company is the leading provider of lottery and gaming operations in the Caribbean and also provides remittance and cambio services.
SVL utilises a 10-member board which is chaired by its co-founder, Paul Hoo. The company has adopted a corporate governance charter seeking to maximise shareholder value by reducing conflicts of interest that may sully efforts to utilise company resources in the best interests of stakeholders.
The board, however, has only three members - 30 per cent - who are independent, versus the international best-practice standard of 75 per cent. Many of the board members also hold directorships of three or more companies, which is conflicts with global best practices.
The company derives its revenues from four main business lines, namely lottery, gaming and hospitality, financial services, and pin codes.
Lottery: Revenues are generated from sales of lottery games: Cash Pot, Lotto, Lucky 5, Pick 3, Super Lotto, Dollaz, and WinQuick. For the six-month period ended June 2010, the lottery segment accounted for 87 per cent of revenues and generated J$359 million in operating profits. The Cash Pot game is the major revenue earner for this segment and accounts for approximately 80 per cent of total lottery revenues, while Pick 3 and Lotto account for 15 per cent of sales in aggregate.
Total revenues for the lottery segment have grown at a compounded annual growth rate of 15.9 per cent since 2005, amounting to J$24.7 billion for the 2009 financial year.
Sales growth throughout the period has been driven by marketing, the introduction of new games, as well as enhancements to existing games to increase appeal.
Gaming and Hospitality: Income from the segment is attained from Video Lottery Terminal games offered at SVL's Acropolis and Coral Cliff gaming lounges, and also from room, restaurant, and guest services offered at these lounges. The company has also recently released a sports-betting product called JustBet.
Revenues from this segment have grown 24.2 per cent on an annually compounded basis since 2006, and accounted for approximately 4.6 per cent of SVL's total revenues as at 2009. Operating profits, however, have been difficult to come by, and as a result, the company has had to close its Villagio lounge and rationalise operating hours for two of its other lounges due to faltering patronage.
Financial Services: This division comprises cambio services and remittance services offered by SVL's MoneyGram operation, which has the largest agent base in the country. The segment accounts for less than one per cent of SVL's total revenues and has seen annually compounded growth of approximately 32 per cent since 2005.
This segment is highly dependent on the level of remittances coming into the country and tends to falter when economic forces put downward pressure on remittance inflows.
Pin Codes: SVL earns income from the sale of pin codes for mobile phone credit through its agent network. Sales from this segment contribute the second most to revenues and have moved from J$550 million in 2005 to J$1.9 billion in 2009, a growth rate of 36 per cent.
Movement in this division can be attributed to the growth in the usage of mobile phone credit over the period, as well as the company's expanding agent network over the period.
The lottery products that SVL provides are discretionary in nature, and as such, are highly dependent on the state of the overall economy and its impact on consumer disposable income.
For the period January-June 2010, Jamaica experienced a contraction in real GDP of 1.5 per cent. This partly reflected the effects of the unfavourable weather conditions and the protracted global downturn, which continued to hurt both the goods-producing and service sectors.
Inflation for the period was 6.8 per cent, and was spurred by movements in the food and non-alcoholic beverages division, increases in the price of oil, and tax increases.
The unemployment rate as at June 2010 stood at 12.4 per cent and represents a high not seen since December 2002.
These negative indicators were all reflected in SVL's slender revenue growth of only one per cent, and a decline of 2.8 per cent from the lottery segment for the six months ended June.
Looking ahead, growth for the Jamaican economy is expected to remain sluggish, due to the absence of countercyclical policies to stimulate the economy and the recurrent weaknesses in key industries.
These indicators suggest that SVL should continue facing growth resistance over the near term as discretionary income, which forms the basis of patronage for the company's products and services, continues to remain weak.
FINANCIAL STATEMENTs ANALYSIS
SVL has come under severe pressure, due to the harsh economic environment in which it operates, which has led to poor results for its half year. For the six months ended June 2010, SVL reported net profit of J$234 million, down 30 per cent, or J$100 million, from the corresponding period of 2009.
Influenced by depressed consumer disposable income, a continued decline in remittances, and greater-than-expected stability of the local dollar, the company has seen a slowdown in growth of most of its business lines as revenues rose only marginally by one per cent to J$12.5 billion for the period.
The pin code segment was the only division recording any significant growth, with a 26 per cent increase in revenues to J$945 million, while the lottery segment posted flat revenues of J$10.9 billion as Super Lotto continued to perform far below company expectations.
The gaming/hospitality and financial services segments posted 9.5 per cent and 15 per cent declines, respectively, to J$522 million and J$74 million.
Cost of sales increased 1.4 per cent to J$11 billion from J$10.9 billion, and resulted in gross profits of J$1.45 billion. Total operating expenses increased 16 per cent to J$1.1 billion from J$975 million, and were driven by costs incurred in the start-up of Acropolis Portmore, and also the rollout of its new sports-betting venture, JustBet.
Resulting operating profits experienced a 36 per cent decline to J$322 million from J$504 million.
Interest income rose 33 per cent to J$45 million while foreign-exchange gains and finance costs both declined by 68 per cent and 37 per cent, respectively, to J$6.7 million and J$9.1 million. SVL's resulting net profit attributable to shareholders registered a decline of 30 per cent for the period to J$234 million, with EPS moving from 12.66 cents to 8.86 cents.
As at June 2010, SVL's total assets stood at J$4.7 billion, 8.7 per cent more than the J$4.3 billion reported in June 2009.
The company's long-term debt fell 75 per cent to J$52 million from the J$210 million as at June 2009. Shareholders' equity increased 10 per cent to J$3.3 billion.
SVL's return on equity has averaged just above 20 per cent for the past five financial years. The profitability measure has consistently been driven by asset turnover, which is typical for companies in this sector. This effective utilisation of assets, rather than a reliance on leverage, speaks to the fact that gains could be derived from altering their capital structure by slightly increasing debt.
The challenges currently being faced by the company are expected to continue for the remainder of the financial year and going into the new year, with the lottery and gaming and hospitality segments expected to suffer the most as these are the business lines that are tied most closely to consumer disposable income.
Though new games have been introduced, and existing games such as Pick 3 have been modified to stimulate sales, the group has yet to find success in countering the downward trend that revenues are currently undergoing.
With unemployment at historically high levels and not expected to improve much for the near term, it is expected that SVL will find it extremely difficult to deliver improved bottom-line performance for shareholders.
SVL is expected to complete the next 12-month period with results that reflect the harsh macroeconomic environment. In the context of a projected decline in GDP, we expect to see lottery sales faltering as consumers grapple with the diminishing real values of their dollars, and cope with allocating those dollars to increasingly costly staples.
The company's other segments, which contribute slightly to revenues and significantly less so to profit, are also expected to come under pressure as both a sluggish US economy and a tepid forex market take a toll on remittance and cambio profits, respectively.
With the bleak economic outlook and its expected impact on revenue growth, SVL will have to place some focus on cost cutting in the near to medium term to mitigate the falling sales.
This given, revenues for the 12 months to end June 2011 are expected to register a 2.5 per cent decline to J$27.6 billion.
Margins are projected to come under some pressure as products such as the Super Lotto, JustBet, and the newly opened lounge in Portmore struggle to gain traction while demanding significant marketing and other resources.
As such, net profit for the period should be an approximate J$580 million, or an EPS of 22 cents.
To arrive at a valuation for SVL, the price to earnings (P/E) and free cash flow to equity (FCFE) models were utilised. More than one model was used in order to ascertain a more robust estimate of company value.
The price multiple method was used because SVL has traded in a particular band in its recent history that has been close to its intrinsic P/E. The FCFE model was used because the company has been free cash-flow positive, and these cash flows have related directly to the company's profitability.
P/E Valuation: In ascertaining a justified P/E, a dividend payout ratio of 70 per cent, which is in line with the historical average, was used. The cost of equity of 16.1 per cent was calculated using the capital asset pricing model, with beta, risk-free rate, and equity risk premium estimates of 1, 12.5 per cent, and 3.61 per cent, respectively.
The beta used was the five-year monthly beta for the stock relative to the JSE Market Index. The long-term growth rate used was eight per cent and was assumed from long-term economic growth forecasts in conjunction with company-specific factors such as business-cycle stage and industry-profitability prospects.
Inputting these assumptions into the model yields a P/E ratio of 8.65x. This compares to a current P/E of 10x and a historical average of about 8.5x. Applying this P/E to the EPS estimate gives a price of J$1.90.
FCFE Valuation: A two-stage FCFE model, which uses the same inputs as highlighted above, yields a price-per-share estimate of J$2.46.
The two methods suggest a price-trading range of J$1.90 to J$2.46, or an average price of J$2.18. Given the current price of J$2.17, a HOLD is recommended for SVL at this time.
Technical Analysis: Technical analysis is also supportive of this view, with a relative strength index reading of 49.11. The stock is trading within the neutral zone and may be viewed as appropriately valued.