Rank Group — Update 26 January 2017

Consumer

Rank Group

Cost pressures, but good digital progress

Interim results

Travel & leisure

26 January 2017

Price	193p
Market cap	£754m
€1.17/$1.26/£
Net debt (£m) at 31 Dec 2016		33.0

Shares in issue	390.7m
Free float	29%
Code	RNK

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(0.1)	3.3	(30.8)
Rel (local)	(1.4)	1.1	(42.5)

52-week high/low

281p

189p

Business description

Rank is a gaming-based leisure and entertainment company. Its Grosvenor and Mecca brands are market leaders in UK multi-channel gaming and it also has operations in Spain and Belgium.

Next events

IMS	May 2017
Final results	August 2017

Analysts

Jane Anscombe	+44 (0)20 3077 5740
Katherine Thompson	+44 (0)20 3077 5730

gaming@edisongroup.com

Edison profile page

Rank Group is a research client of Edison Investment Research Limited

Interims reflected high street cost pressures (EBITDA -5%) and we have trimmed FY17e EPS by 2%. However, Digital’s 11% revenue growth was very encouraging, with an acceleration in Q2 as platform problems were ironed out. The core argument for Rank remains intact: scope to materially grow in Digital via better cross-sell of its land-based brands. Despite a lacklustre short-term profits outlook, the group remains highly cash generative, which underpins a progressive dividend policy and FY17e yield of 3.7%. The FY17e EV/EBITDA is only 6.2x, 37% below the peer average.

Year end	Revenue* (£m)	EBITDA** (£m)	PBT** (£m)	EPS** (p)	DPS (p)	P/E (x)	Yield (%)
06/15	738.3	126.3	74.1	14.6	5.6	13.2	2.9
06/16	753.0	128.2	77.4	15.4	6.5	12.5	3.4
06/17e	764.0	127.0	76.0	15.3	7.1	12.6	3.7
06/18e	780.7	133.0	81.5	16.4	8.2	11.8	4.2

Note: *Revenue is before customer incentives. **Normalised, excluding amortisation of acquired intangibles, one-off and exceptional items.

Challenging retail trading conditions

Rank’s H117 revenue grew by 1% to £379m (2% l-f-l), but increased inflationary and employment costs left normalised PBT 8% lower at £34.5m. Grosvenor Casinos was affected more than Mecca, partly due to a strong comparative. Management has cut costs across the group and H217 should benefit to the tune of £8m (2.5% of the cost base). Our revised FY17e normalised PBT of £76.0m (previously £78.5m) implies H217 growth of 3.8% and moves us to the lower end of the current consensus. Rank remains strongly cash generative: net debt fell to £33.0m at end December (June 2016: £41.2m) and we expect a further decline to £23.0m by year-end, despite capex being weighted to H217.

Encouraging progress in digital

Digital revenue growth of 11% compared with 7% in Q117 (to 9 October). Grosvenor digital revenues jumped by 39%, helped by a much better product range. Mecca digital returned to growth in Q217 (3% versus -4% in Q117) with the new Bede platform now handling its high-volume traffic robustly. Operational integration of the two brands is already improving effectiveness. Digital is still only 14% of the group and we now expect this side of the business to move ahead rapidly, increasingly offsetting economic pressures on the venues’ results.

Valuation: FY17e EV/EBITDA only 6.2x

Rank shares fell by 32% in 2016 due to disappointment over Mecca digital delays and the more uncertain consumer outlook. High street pressures will continue to weigh on results until Digital scales up. However, a 2017e EV/EBITDA of 6.2x and P/E of 12.6x are well below the peer group averages of 9.8x and 15.3x respectively despite Rank’s fully regulated status, leading brands and opportunity in Digital. We believe that organic growth may be augmented by acquisitions in due course, in a consolidating market.

Interim results and full year forecasts

H117 revenue increased by 1.2% to £378.6m, but normalised operating profit fell by 9.4% to £36.6m. All the divisions were lower bar the small Spanish operation, Enracha, which had an excellent half. Normalised PBT of £34.5m was 7.7% down despite a reduction in interest charges, and was below the £37.0m we forecast in our 14 October AGM update note due to a weaker than expected result in Grosvenor Casinos. However, management action on costs means that the CEO expects the full year performance to be “in line with market forecasts”. We summarise the main trends below and plan to release a longer Outlook report shortly.

Exhibit 1: Half-yearly results and estimates

Year to June £m	H116	H216	FY16	H117	H217e	FY17 new	FY17 old	FY18 new
Grosvenor venues	205.1	203.0	408.1	202.0	203.0	405.0	415.5	407.0
Mecca venues	109.8	111.7	221.5	108.0	109.0	217.0	219.0	215.0
UK digital	47.1	49.6	96.7	52.4	56.6	109.0	112.5	122.7
Enracha	12.2	14.5	26.7	16.2	16.8	33.0	30.0	36.0
Revenue*	374.2	378.8	753.0	378.6	385.4	764.0	777.0	780.7
EBITDA	62.7	65.5	128.2	59.7	67.3	127.0	130.0	133.0
EBITDA margin %	16.8%	17.3%	17.0%	15.8%	17.5%	16.6%	16.7%	17.0%
Depreciation/amortisation	(22.3)	(23.5)	(45.8)	(23.1)	(23.9)	(47.0)	(47.0)	(48.0)
Grosvenor venues	30.9	30.0	60.9	26.1	28.9	55.0	63.5	56.5
Mecca venues	14.3	18.6	32.9	13.3	17.2	30.5	29.0	30.0
UK digital	8.0	5.9	13.9	7.3	7.2	14.5	14.5	17.0
Enracha	1.4	2.2	3.6	2.9	2.6	5.5	4.1	6.0
Central costs	(14.2)	(14.7)	(28.9)	(13.0)	(12.5)	(25.5)	(28.1)	(24.5)
Operating profit (norm)	40.4	42.0	82.4	36.6	43.4	80.0	83.0	85.0
Group margin	10.8%	11.1%	10.9%	9.7%	11.3%	10.5%	10.7%	10.9%
Net interest	(3.0)	(2.0)	(5.0)	(2.1)	(1.9)	(4.0)	(4.5)	(3.5)
Profit before tax (norm)	37.4	40.0	77.4	34.5	41.5	76.0	78.5	81.5

Source: Rank Group, Edison Investment Research. Note: *Revenue is before customer incentives.

Grosvenor venues

Revenue was flat on a l-f-l basis (reported down 2%), affected by a slightly below average win margin and a 6% reduction in customer visits, not helped by tighter customer due diligence checks. We believe this is slightly better than the industry average and indeed Rank reports that in October 2016 Grosvenor achieved its highest share of admissions in four years. Both London and the provinces were affected and operating profit fell by 16% (EBITDA down 10%). The Q2 l-f-l (+1%) was better than Q1 (down 1%), albeit that there was a slightly easier comparative, and we expect cost savings to contribute to a slightly improved result in Q2. We do not expect Grosvenor to be affected by the government’s current triennial review into stakes and prizes, but there is more upside than downside since any restrictions on FOBT betting terminals in betting shops might help the casinos, as would an increase in the number of machines permitted in casinos (which Rank is pushing for and which could be a major positive).

Mecca venues

L-f-l revenue was flat (reported fell by 2% due to the closure of two clubs), which we view as a solid outturn, with higher average spends (especially on the Mecca max machines) offsetting lower visits. A 9% increase in main stage bingo was encouraging. However, operating profit fell by 7% (EBITDA down 8%) due to lower revenue and the impact of higher employment costs.

UK digital

grosvenorcasino’s revenue increased by 39% to £19.3m, implying a strong Q2 (Q1 revenue rose 30%). Rank materially improved the product offering in the period with the launch of its sportsbook (Kambi-powered) and improved poker product, as well new games. Only 3% of Grosvenor venues’ customers play at grosvenorcasino.com and this is a key cross-sell opportunity; encouragingly, 15% of venues’ customers are now using the new sportsbook. meccabingo revenues were flat at £33.1m, but this implies 3% growth in Q2 after -4% in Q1. Mecca had been much more affected by the migration to the Bede platform than Grosvenor due to its much higher volumes, with the business about six months behind target, so we view the Q2 trend as very positive, with the next six months an important proving period. UK Digital operating profits declined by 9% in H117 (EBITDA was flat), but the divisional restructuring (merging the two brands under a single team) and new Sheffield customer solutions hub means that we now expect margins to improve rapidly as the business scales up (even allowing for the extension of the UK RGD gaming duty to ‘free play’ from August 2017).

Changes to forecasts

Exhibit 1 shows our old and new FY17 forecasts by division, showing that the reduction in our forecast operating profit (from £83.0m to £80.0m) arises entirely in Grosvenor venues, where we will be keeping a close eye on trends in the coming months. Exhibit 2 summarises the headline changes. Management has implemented cost savings across the group, which are expected to save £8m in the second half, eg a back-of-the-envelope approach would be to add double the H1 result (to £73m of operating profit) and add £8m to arrive at £81m (Edison estimate £80m). The exceptional restructuring costs of £8.0m (£3.8m booked in H117) are offset by a £10.7m lease provisions release and we forecast a net £2.4m of exceptional charges for the full year. We have trimmed FY18 estimates by slightly more than FY17, given the uncertain consumer outlook, with PBT and EPS down by c 4%.

Exhibit 2: Changes to forecasts

	EBITDA (£m)			PBT (£m)			EPS (p)
	Old	New	% chg.	Old	New	% chg.	Old	New	% chg.
FY17e	130.0	127.0	(2.3)	78.5	76.0	(3.2)	15.6	15.3	(1.9)
FY18e	137.5	133.0	(3.3)	86.0	81.5	(4.5)	17.1	16.4	(4.1)

Source: Edison Investment Research

Very strong cash generation

Rank is highly cash generative. Net debt fell from £41.2m at 30 June 2016 to £33.0m at 31 December (net debt/EBITDA leverage down to 0.3x). First half capex was £17.0m (H116: £26.1m) and management has guided that it now expects to spend £50-55m for the year (previous guidance: £60-70m), partly due to ongoing planning delays in securing sites for the new Luda high street bingo brand and partly due to a general reining back, especially with Grosvenor electronic machines. As a result we now forecast year end net debt of only £23m (previously £36.0m) and continue to expect the group to be cash positive by the end of FY18, in the absence of any material acquisitions.

Dividends

Rank has a progressive dividend policy and the interim payout was increased by 11% to 2.0p. Our full year forecast is unchanged at 7.1p (2.2x cover) and we expect a move towards 2.0x cover in FY18.

Exhibit 3: Financial summary

	£'m	2014	2015	2016	2017e	2018e
June		IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		707.7	738.3	753.0	764.0	780.7
Cost of Sales		(409.2)	(414.2)	(427.1)	(437.8)	(447.3)
Gross Profit		298.5	324.1	325.9	326.2	333.4
EBITDA		116.0	126.3	128.2	127.0	133.0
Operating Profit (before amort. and except.)		72.4	84.0	82.4	80.0	85.0
Intangible Amortisation		0.0	0.0	0.0	0.0	0.0
Exceptionals		(46.5)	2.1	9.3	(2.4)	0.0
Operating Profit		25.9	86.1	91.7	77.6	85.0
Net Interest		(9.9)	(9.9)	(5.0)	(4.0)	(3.5)
Other finance adjustments*		(1.6)	(1.7)	(1.1)	(0.9)	0.0
Profit Before Tax (norm)		62.5	74.1	77.4	76.0	81.5
Profit Before Tax (FRS 3)		14.4	74.5	85.6	72.7	81.5
Tax on norm PBT		(13.9)	(17.0)	(17.4)	(16.3)	(17.5)
Profit After Tax (norm)		48.6	57.1	60.0	59.7	64.0
Profit After Tax (FRS 3)		0.5	57.5	68.2	56.4	64.0

Average Number of Shares Outstanding (m)		390.7	390.7	390.7	390.7	390.7
EPS - normalised (p)		12.4	14.6	15.4	15.3	16.4
EPS - (IFRS) (p)		5.2	19.1	18.2	14.2	16.4
Dividend per share (p)		4.50	5.60	6.50	7.10	8.20

Gross Margin (%)		42.2	43.9	43.3	42.7	42.7
EBITDA Margin (%)		16.4	17.1	17.0	16.6	17.0
Operating Margin (before GW and except.) (%)		10.2	11.4	10.9	10.5	10.9

BALANCE SHEET
Fixed Assets		613.3	607.2	614.1	621.0	626.0
Intangible Assets		390.2	395.7	404.3	405.0	406.0
Tangible Assets		217.5	204.0	202.0	208.0	212.0
Deferred tax/other		5.6	7.5	7.8	8.0	8.0
Current Assets		87.9	123.4	100.5	107.0	116.2
Stocks		3.1	2.8	2.9	3.0	3.2
Debtors		37.7	31.0	36.6	37.0	38.0
Cash		47.1	89.6	61.0	67.0	75.0
Other		0.0	0.0	0.0	0.0	0.0
Current Liabilities		(168.4)	(309.4)	(173.9)	(182.0)	(184.5)
Creditors (incl provisions)		(164.0)	(184.5)	(159.5)	(167.0)	(170.0)
Short term borrowings		(4.4)	(124.9)	(14.4)	(15.0)	(14.5)
Long Term Liabilities		(290.5)	(126.8)	(188.1)	(165.0)	(135.0)
Long term borrowings		(179.7)	(17.6)	(87.8)	(75.0)	(55.0)
Other long term liabilities		(110.8)	(109.2)	(100.3)	(90.0)	(80.0)
Net Assets		242.3	294.4	352.6	381.0	422.7

CASH FLOW
Operating Cash Flow		55.0	146.6	110.2	115.2	130.0
Net Interest		(8.1)	(7.5)	(5.0)	(3.0)	(3.0)
Tax		(19.1)	(2.2)	(31.1)	(13.7)	(16.3)
Capex		(44.3)	(31.9)	(52.7)	(50.0)	(48.0)
Acquisitions/disposals		0.3	(1.0)	16.2	0.0	0.0
Financing		0.0	0.0	0.0	0.0	0.0
Dividends		(16.4)	(18.6)	(22.7)	(26.6)	(30.9)
Net Cash Flow		(32.6)	85.4	14.9	22.0	31.9
Opening net debt/(cash)		104.1	137.0	52.9	41.2	23.0
HP finance leases initiated		(2.3)	(3.1)	(2.8)	(3.0)	(3.0)
Other		2.0	1.8	(0.4)	(0.8)	(0.3)
Closing net debt/(cash)		137.0	52.9	41.2	23.0	(5.5)

Source: Rank Group accounts, Edison Investment Research

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New York +1 646 653 7026

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Level 25, Aurora Place

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NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

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