SkyCity Entertainment Group Limited (SKC) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the SkyCity Entertainment Half Year 2023 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Michael Ahearne, Chief Executive. Please go ahead.

[Foreign Language], and good morning. Welcome everyone to SkyCity's investor call on the FY '23 interim results. I would firstly like to recognize traditional custodians on the land upon which all our SkyCity [ side fit ]. Ngati Whatua Orakei in Auckland, Tainui in Hamilton, Ngai Tahu in Queenstown and the Kaurna people in Adelaide, [Foreign Language]. With me today in Auckland is Julie Amey, our Chief Financial Officer; and Callum Mallett, our Chief Operating Officer, New Zealand. Our investor presentation on the interim results was released to the stock exchange earlier this morning. We're going to take that presentation as read and hence focus on the key themes and our observations across the period leaving time for Q&A at the end. Turning to the key themes for the first half of the financial year. I want to start by saying that I feel incredibly proud of how our team has dealt with the opportunities and challenges over this period, and in particular, our frontline employees, who have been incredibly flexible as we've navigated through a positive recovery in customer visitation in the first half in 3 years, where we had no mandated closures. This has been a period of intense regulatory focus, which has taken considerable effort and diligence from management on both SkyCity Entertainment Group and SkyCity Adelaide Board. I'll address this in more detail later. We had a strong first half financial performance, noting that the prior year period was significantly impacted by COVID-19. Group normalized revenue of $487.4 million was up 87% year-on-year and just 6% below FY '19 half 1 normalized revenue performance. Normalized EBITDA of $162.4 million was up 348% year-on-year and pleasingly in line with FY '19's normalized EBITDA performance. The group's normalized NPAT of $73.1 million was up well over 400% year-on-year. And we've also declared an interim dividend of $0.06 per share. From these results, it's evident that our businesses have once again recovered quickly from the significant adverse impacts we experienced as a result of the pandemic period across our New Zealand and Australian businesses. I am thankful for our operational staff and leadership team for their focus on customer experience, operational improvement and cost management, all of which has positioned our business well to deliver the strong recovery in revenue and earnings. We successfully completed collective wage agreements both in New Zealand and Australia in the period, which was a positive outcome for our employees and the business. Retention and recruitment of our people has been a significant priority for the group. And while we have made a lot of progress on recruitment, there are still a large number of vacancies across the group, approximately 450 positions, particularly in Auckland. Positively, we are seeing a material increase in the number of applications roles. Given resourcing constraints, we continue to prioritize our resources to our highest performing businesses. As an example, our Auckland outlets in the first half '23 are operating at approximately 55% of the capacity that they operate at pre-COVID. We are planning to start expanding our operations in the near term through reopening and expanding the hours of outlets that are currently either closed or operating under capacity constraints. In Auckland, we're seeing continued positive momentum in the New Zealand International Convention Center and Horizon Hotel project. We expect the convention center car parks to be progressively returned to the operation during 2023. Horizon Hotel to be completed in 2024 and the convention center to be completed in 2025. The project remains complex, including the insurance arrangements, but we remain comfortable with our contractual position. The process in relation to the buyback of the Auckland car park concession from Macquarie is underway, and we expect to conclude the process in this financial period. We have in place the appropriate funding through a combination of existing liquidity and additional USPP financing. As I mentioned earlier, and as you're all aware, regulators across Australasia remain highly focused on the casino industry. The New Zealand regulator, the Department of Internal Affairs continues to undertake routine reviews of our casino operations, including our compliance with AML and host responsibility obligations. DIA has expanded its resourcing over the past 12 months. We continue to work proactively on enhancements to discuss the New Zealand host responsibility and AML capabilities. As you know, AUSTRAC commenced civil penalty proceeding against SkyCity Adelaide in November -- sorry, in December '22. We are currently working with our legal advisers to review and assess AUSTRAC's statement of claim and each of the specific allegations that it contains, but there is still considerable work required to complete that process. It could take 1 to 2 years to resolve these proceedings. As we've previously disclosed, any associated penalties could have a significant financial and reputational impact on SkyCity. We continue to cooperate with the South Australian regulator, CBS, in relation to the independent review of SkyCity Adelaide. As you will be aware, in July 2022, CBS appointed Brian Martin KC to undertake an independent review of SkyCity Adelaide in light of interstate inquiries into various casino operations in Australia. The independent review was a major focus for the SkyCity Adelaide team in the half, which involves responding to extensive information and document requests as well as interviews with employees and directors. On the 6th of February 2023, the commissioner advised that Mr. Martin had formed a view that until the resolution of the AUSTRAC proceedings, it was not possible to reliably determine the question of suitability. On that basis, the commissioner has determined to put the independent review on hold and has extended time for the provision of a written report of the findings of the independent review until after the conclusion of the AUSTRAC proceedings. The commissioner has also advised that he's considering his options regarding any action he should take whilst the independent review is on hold, including whether he will seek that the company undertake any actions in the interim. SkyCity Entertainment Group and SkyCity Adelaide will continue to cooperate with CBS and any further request for information and documents. We also continue to progress our AML and host responsibility enhancement programs across the group. This area remains a major focus for both SkyCity management and our Board. We continue to have regular dialogue with AUSTRAC as we progress the AML uplift program in Adelaide. As part of the uplift activities, we put in place new senior AML resourcing in both New Zealand and Adelaide, improved governance and investment on ICT systems and KYC processes. We have also recently implemented a number of positive initiatives in SkyCity Adelaide to further enhance our AML/CTF processes, including the introduction of a cash limit of 5K -- $5,000 per day per customer as well as a mandated carded play for all customers in our VIP rooms. Moving now to performance of our properties, as outlined on Slides 9 through to 14 in the presentation pack. Auckland has performed strongly with normalized EBITDA of $128 million at a very strong margin in excess of 45%. This has been a record performance for the property in a 6-month financial period, largely driven by domestic visitation with a recovery from international tourism in Q2 and a focus on operational execution. The gaming machine business has been a highlight with strong revenues driven by growth in all segments, in particular, the main gaming floor. Continued investments in product and the recovery of domestic visitation have been the key drivers. Table games continues to recover, albeit at a slower pace than electronic game machines. The non-gaming operations, hotels, food and beverage and attractions have recovered quicker than anticipated and have benefited from the recovery of international tourism, which we anticipate will continue. This performance has been achieved even though the majority of our open outlets have operated at reduced capacity and some have yet to reopen. Auckland margins were exceptionally strong, driven by the work done by the management team on operating model refinement and cost discipline, but were potentially slightly inflated due to labor shortages. While open had a very strong half, revenue with the exception of electronic game machines is still well short of pre-COVID levels, highlighting the continued growth opportunity in this business. The SkyCity Hamilton and SkyCity Queenstown businesses have performed very well in the period, driven by strong local visitation and activity. In particular, SkyCity Hamilton business generated in excess of $19 million normalized EBITDA in the half, which is a record for the business. We've continued to invest in new gaming product and the changes that have been made in the operating model are proving beneficial. We've also plans to open a new restaurant at SkyCity Hamilton in April this year. Operational momentum continues at SkyCity Adelaide with a very strong performance in electronic game machines offsetting a slower recovery in table games. The non-gaming operations continue to gain momentum with our award-winning hotel, Eos by SkyCity, delivering strong rates and occupancy. However, Adelaide has seen significant growth in costs, which has impacted margin, such as increased utility costs, increased compliance resourcing costs and additional legal costs. The international business, which was largely focused on domestic Australian activity has had relatively low levels of activity as anticipated. The SkyCity Online Casino performed well in the half, but slightly down on the prior year, which was assisted by COVID-19 lockdowns. A strong brand and product continued to deliver high customer retention rates. The increasing competition in the New Zealand online gaming market reinforces the need for regulation and a level playing field. We continue to actively advocate for the regulation of online gaming in New Zealand. However, it is unlikely we'll see significant progress in 2023, given the general election in New Zealand later this year. We are currently exploring whether we could enter the Ontario market as a regulated operator. SkyCity's investment in Gaming Innovation Group is proving beneficial from both a strategic and financial perspective with that company advancing its growth objectives over the period. I will now hand over to Julie to make some comments on our financial and capital management before closing. Julie?

[Foreign Language] Michael, and kudos to everyone listening in. It's great to be able to share such strong financial performance from across our group for the first half of the period, particularly after a couple of very challenging years. The group's reported EBITDA of $106 million and reported NPAT of $23 million for the period demonstrates the capability of our businesses to recover quickly from adverse events. This is even more evident from the normalized earnings performance, which removes the largely technical accounting adjustments to enable a better understanding of the underlying operational performance of the group. I refer you to Slide 8 in our investor presentation, which summarizes the financial performance and highlights the recovery in the group's normalized EBITDA to deliver $162 million with a margin of over 33% for the period. Of our normalized group revenue delivery of [ $487 million ], 50% was from local EGMs. And this performance is 30% higher than EGM revenue for the same period in the 2019 financial year. And while table games remains our second largest revenue contributor in the period at [ $118 million ], this was 13% softer than the first half of 2019 and a clear indication of a slower recovery for tables post COVID-19. Hospitality was a meaningful contributor in the first half, delivering 13% of the group's normalized review. And this is around 20% higher than the same period in the 2019 financial year. But with a significant upside from Adelaide post the expansion, offset by the operating constraints in Auckland that Michael referred to earlier, with 11 of our 12 Auckland food and beverage outlets operating at availability well below the pre-COVID-19 levels. And as an example, during the first half period, our most popular and profitable restaurant, [ Albert ], which happens to feature on the cover of our investor presentation, only operated at around 57% of its capacity compared to pre-COVID-19 operating levels. It was great to welcome 1,200 new employees to our SkyCity [ funnel ] during the first half of the financial year. But there still remains a significant number of vacancies that need to be filled in order for our businesses to operate without resourcing constraints. The ramp-up in staff also brings a ramp-up in our manpower cost with manpower continuing to be the single biggest expense of the group at around 50% of our cost base. An increase in the cost of compliance of our compliance activity was also a feature in the first half with $9 million spent during the period on both the one-off regulatory responses and enhancement activities and also on the ongoing baseline activity, host responsibility and financial crime departments. And on the ongoing baseline compliance activity, we expect the cost of our financial crime and host responsibility departments to be around $10 million annually, which is about 3x higher than in the 2020 financial year. As I mentioned earlier, our reported and normalized results differ considerably in some areas. A detailed explanation of these differences is included in the appendices of the presentation. These differences include adjustments for our Auckland investment property valuations that are independently assessed every reporting period against the fair market value of the Auckland commercial real estate market. Fire accounting for the New Zealand International Convention Center project remains complex, but this will simplify as the project moves out of the reinstatement phase and back into the construction phase. I will also call out that there has been an adjustment to this fire accounting that was triggered by Macquarie exercising its termination option under the Auckland car park concession agreement. All other accounting adjustments that will be required in relation to unwinding the concession agreement will be made when the buyback of the concession is complete. Moving on to our balance sheet. Our capital spend during the period was relatively low at $23 million compared to the run rate of BAU CapEx in a normal year. Our focus has remained on affordability during the period and directing our capital spend largely to core maintenance and upgrades to ensure we retain our health and safety standards and on gaming product replacements to grow our customer value proposition. The group also remains financially resilient with borrowings of $391 million at 31st of December 2022 and a healthy level of liquidity headroom of $475 million, which includes $390 million of syndicated debt that remains undrawn to date. We are also no longer reliant on debt covenant relief from our banking syndicate and USPP partners, having met our standard covenant test at 31st of December 2022, with a gearing of 1.6x. The listing of these restrictions covered with our strong normalized NPAT performance and free cash flow delivery has enabled us to declare an interim dividend of $0.06 per share. This dividend is in line with SkyCity's existing dividend policy. As Michael mentioned earlier, we have also successfully secured new structured funding of USD 75 million from our USPP partners, which will help to finance the buyback of the Auckland car park concession. We are very mindful of the uncertainties in our operating environment. And we'll continue to retain an appropriate level of liquidity headroom to make sure the business remains sustained as we navigate these uncertainties. However, we do expect this headroom to reduce over time and back to the liquidity thresholds as determined by our treasury policy. And regarding these uncertainties, as Michael mentioned earlier, any associated penalties related to the AUSTRAC proceedings could have a significant financial and reputational impact on SkyCity. We have included a very comprehensive note in our interim financial statements on the proceedings, and I want to call out, in particular, that it is not yet possible to reliably estimate a provision for any potential financial penalty that may arise. And before I hand back to Michael for a trading update, I want to thank our financiers and our investors for the great support we have received as we navigate our regulatory matters and our post COVID-19 recovery. The group is entering the second half of the financial year in a very strong position, and we look forward to closing out the financial year in the same way. So now over to you, Michael, for the trading update.

Thanks, Julie. A few comments around recent trading and our focus for the remainder of the year. I'm pleased to say that the revenue trends observed in the first half of the financial year have largely carried over into January with no indications yet of a recessionary environment, although the group remains cautious. International tourism recovery is anticipated to continue, which assists the Auckland precinct in particular. We continue to see significant cost pressures across the group, including operational costs such as salaries, wages and utilities and legal costs associated with the AUSTRAC enforcement investigation and proceedings -- and proceedings and the CBS independent review. We have also established a Chief Risk Officer position that we are currently undertaking a search for. We do not anticipate any material activity in the international business in the second half. Financial year '23 normalized EBITDA is expected to track ahead of FY '19 levels on a like-for-like basis with estimates ranging from $305 million to $320 million, excluding any upside from the integration of the Auckland car park post completion of the buyback of the car park concession from Macquarie. This assumes no significant changes to the group's operating environment and settings. It will come at no surprise to you that a significant amount of my time, my management team's time and the Board time will continue to be prioritized on our regulatory matters and ensuring that our enhancement programs put in place meet the expectations of our regulators and are sustainably embedded deep into the organization. As mentioned at our annual meeting last year, progress continues to be made from a governance perspective. We have established a separate Audit Committee chaired by Chad Barton and Risk and Compliance Committee chaired by Kate Hughes. The SkyCity Adelaide Board is chaired by Glenn Davis, who is also a SkyCity Entertainment Group Director and is based in Adelaide. And subject to regulatory approvals being obtained, David Attenborough will become a Director of the SkyCity Entertainment Group Board from the 1st of March 2023. David has extensive experience in the gaming industry in Australia and globally and is well known to most of you on this call. In summary, the first half was pleasing from an operational performance perspective and again highlights the potential within our business. But there continues to be significant regulatory scrutiny and focus on our business, and we continue to focus on enhancing our AML and host responsibility practices. I want to personally thank all of our investors and shareholders and financiers both on this call and more broadly for your ongoing support. With that, I will hand back to the operator for Q&A.

[Operator Instructions] Our first question comes from the line of Justin Barratt of CLSA. It seems we've had a disconnect from Justin Barratt. One moment for our next question. Our next question comes from the line of Matt Ryan of Barrenjoey.

Michael, I just got a question on the enhancement programs in Adelaide and whether you can clarify where the use of carded play is going to be required? I think you sort of mentioned that carded play is now required in VIP rooms. But if you could just clarify whether that includes all private rooms or just the rebate business? And then just on the program, I know it's really early days, you obviously rolled out a lot of the stuff just in January. But just curious as to what your thoughts are around the initiatives and what sort of impact you're expecting to play moving forward?

Matt, thanks for the question. Look, well, firstly, these initiatives, both the carded play and the limit on cash, these are initiatives initiated by SkyCity. They're not initiatives that have been forced upon us. So the carded play in VIP rooms is going quite well. In VIP rooms, a lot of the play was carded anyway, and very high percentage of -- I think it's in excess of 99% actually that we're achieving there. In time, we don't have technology in place to enforce that right now. So it's been done sort of manually. But in time, we would see that we'll put the technology in place to enforce that. It's early days in relation to those changes that we've made in relation to cash limit. So -- but we will be analyzing those over the next number of months to understand what they mean and so on. And just in relation to the carded play, it's all VIP, not just IB, it's all VIP rooms in Adelaide that we've made that change as part of...

And just a second question just on the guidance for the second half. Obviously, you've had some more subdued table games growth compared to machines. What's your assumption baked into the guidance around table games into the second half?

Yes. Look, I think that table game has been slower than EGMs, has been a trend over a couple of years now, to be honest. So we assume that, that continues. We haven't assumed any major recovery in table games. We are seeing -- in Auckland, in particular, we're seeing the benefit of additional open hours as we bring more staff and we get more employees into our table games area, we're getting more open hours. But we are, I would say, realistic in our expectations from table games.

One moment for our next question. Our next question comes from the line of Larry Gandler of Credit Suisse.

With regards to Auckland's hospitality business, you're obviously indicating and showing that revenue has been impacted by, I guess, scheduling. I'm just wondering about profitability because you have been able to manage through that those scheduling issues, in some cases, may be voluntary. So can you talk to profitability of hospitality in the half? And how do you see it rolling out over the next 6 months, 12 months?

Thanks, Larry. Look, I'll make a few comments, and I might get Callum to give you a little bit more color on that. I think pleasingly, we're seeing a recovery coming through in revenues, but still quite a gap to what we were seeing before. But the work the team are doing generally on enhancing margin through a number of different measures is helping us to run the business, those business, in particular at healthy margins. So maybe, Callum, you want to talk about some of the detail about what you're doing.

Thanks, Michael. Good morning, Larry, and everybody. Yes, so as you've seen significant restrictions for us in the F&B space across New Zealand, to be honest. But, yes, most obviously, in Auckland. As Julie pointed out, we've really focused and prioritized on our highest-margin businesses and highest-margin meal periods. As we discussed at full year results, a big focus on margins for F&B. And a number of you will remember what we talked about reautomation and productivity initiatives. It's pleasing to see that they're having an impact. As you can see, F&B margins at around 20% now versus pre-COVID at around 16%. We think we can keep it around that mark, albeit as we open more outlets. Obviously, we will have to watch that, but demand is there. Right at the moment, on any given day, we have greater demand than we do supply. We're working hard both as a business but also with associations and government entities to help with the staffing in this space, but we see good growth still in our hospitality business as we move into this full year and particularly as we move towards the FIFA tournament in July and August and spring and summer as hopefully, airline capacity grows as well.

Thanks, Callum.

Can I just ask just with regards -- give me sort of a guide for, I guess, overall demand. But Sky Tower, I know it's an important tourist attraction there. Can you give us a feel for whether that's now operating at above pre-COVID levels?

It's getting back towards pre-COVID levels on certain weeks and certain months, Larry. So we've seen a really strong January in the tower despite extremely inclement weather. So it's building back to what we would hope, but certainly, on a half year basis, significantly down from pre-COVID, some good trends.

Yes. So Larry, I think what we're seeing from a trend point of view, we're definitely going to get back to pre-COVID levels of visitation and activity, but we're not there yet, but we're on a pathway there. And with that extra revenue visitation, the new measures that we've put in place that will help drive further growth in our earnings in the Auckland property.

One moment for our next question. Our next question comes from the line of Adrian Allbon of Jarden.

Just a couple of questions. The first one, like are you able to sort of -- like I know you sort of commented like on the earnings front sort of tracking back towards pre-COVID, which this result has demonstrated nicely. But obviously, there's a lot going on in the growth in the next couple of years, like both in terms of finishing capital projects and sorting out some of the regulatory stuff in the car park concession. But how should we think about like returns tracking back to pre-COVID levels? Like with all of that stuff and the mix is tracking back to pre-COVID levels, like optimistic or do you think achievable?

Look, as you say, there's a lot changed in our business pre-COVID. So we have businesses now that we didn't have, online, we didn't have actually pre-COVID, now that's a business on an annualized basis that makes in excess of $10 million EBITDA, and that's a business that has exponential returns. We'll have the new hotel convention center coming on. And you can see the -- we're really positive about those coming back based on the demand we're seeing right now from a tourism perspective and how to fit into the portfolio both directly, but also the indirect benefits that will drive to the Auckland business. And -- but we also have extra costs in our business. And you can see we've handled those costs quite well, I think. But we have very significant extra compliance costs that are a feature of our business as we look forward. So we're not giving specific guide. I don't want to get into specific guidance about the long term of the business. But we see -- we've got back to pre-COVID levels of earnings actually a bit quicker than we thought we would, which is really good. But we see this as a base now at which we grow from in all our businesses, to be honest.

Okay. So some positive mix stuff, but equally a lot of OpEx pressures and responses, and I guess pushing the business stores more cashless still to come on that front.

Yes. Yes.

Just second question around the casino duty staff, obviously, been a major issue with some of the peers. But just can you just sort of give a little bit more detail, firstly, on what sits behind the outstanding in Adelaide, I think it's Note 14, like what would be the sort of magnitude of that kind of investigation?

Look, what I would say, firstly, from a casino duty point of view, we're in a stable environment in New Zealand and in Australia for that matter. That casino duty matter is something that's been ongoing for many, many years, that was just stepping through in the process. So I don't think we've actually disclosed the actual amount on that. So I think we've made a -- whatever is in the notes covers it.

Okay. And then just like -- I mean you sort of started by sort of mentioning like New Zealand being stable. If my understanding is great like the certainty that was sort of signed when you did the building contract for NZICC was 7 years, which has sort of just expired. But what's the sort of process that you're sort of undertaking to sort of manage any sort of change on that front?

So there's not a process. That was an agreement that was put in place. But the casino arrangements in relation to GST and the duties have been in place before that and go back to when the licenses were established. But there's not a process we need to go through to renew anything. It applies, this is redeemed by to all casinos, that exclusivity or change was just in relation to the Auckland property.

Okay. So -- okay. So it's just -- it's BAU on that front for Auckland or you lose as kind of like the certainty that was signed against the contract if someone did want to make a change?

Yes. Any change, there's no movement or any moving of any change that's taxable.

And just on Adelaide. There's effectively any change like [indiscernible] and the sort of exclusivity deal around the license as well. Is that the right way to think about that?

Sorry, I'm not following that. In relation to tax, is it?

Yes. Well, in terms of the casino duty tax, like is that sort of -- was that sort of set with the license extension and exclusivity around -- on that front?

Yes, it was.

Okay.

One moment for our next question. Our next question comes from the line of Mark Robertson of Forsyth Barr.

Congratulations on a very strong first half. I might just follow on from Adrian's last question there and ask in a little bit different way. Obviously, you've got tax certainty in South Australia until 2035. Are there any scenarios where this could be superseded similar to what we have seen with [ Star ] and New South Wales?

Mark, look, it's not something that we're working on or considering, to be honest.

Okay. And then just one other question, just how you're finding the labor markets and the markets you operate. Obviously, it's still a pretty tight labor market, but you're getting easing in that? And how close do you think to nearing stable employment?

It's probably -- in Australia, it's -- it has improved quicker in South Australia and Adelaide has improved quicker than it has here in New Zealand. And look, in fairness, we have made progress over this period. I think Julie mentioned that we've employed about 1,200 people over the course of the past 12 months. Now we've obviously had attrition in that period as well. And our vacancy number remains at over 400, but that's because with more demand, so we're creating more roles. Potentially, we're seeing more -- right now, we're seeing more applicants for open positions than we did, say, 3 months ago. So potentially, it's easing slightly. However, I do think it's going to take at least probably 6 to 12 months. I think in 12 months' time, you would be hoping to have all those positions filled, getting us back to close to 5,000 employees.

Awesome. And then just one more. Just given the recent increase in the minimum wage in New Zealand, can you just remind us how much of your labor force is on that minimum wage?

Well, we've already put an agreement in place and we'll have an increase of flow through in April, I think. So it actually doesn't really apply that we -- in our agreement with the union we came during the year, we already had agreed the element that and it will be above the minimum wage. So it doesn't have any direct impact.