Shares digital

Odds of Irish bookmaker prospering through these tough times look increasingly slim

by Dan Coatsworth

Paddy Power (PAP) €15.60, Stop loss €18.72

Shares summary

Irish bookmaker is sacrificing margins to give punters better odds in a move to keep business rolling during tougher market conditions. This could prompt a wave of earnings downgrades.

Business:

High-street, phone and online bookmaker

Vital stats:

Market value: €769 million

Historic PE: n/a

Prospective PE 2008: 10.8

Prospective PE 2009: 11.4

Sector PE: 12.3

1-month relative strength: -10%

1-year relative strength: -27.5%

Yield: 2.5%

NMS: n/a

Spread: 0.13%

Bookies often claim consumers continue to bet through recessions but the risk of lower margins from a newly initiated price war and deteriorating economy suggests investors should bet against Paddy Power prospering in the short term. Sell the stock ahead of half-year results on 27 August.

Paddy Power is guaranteeing best prices on all horse and dog races in the UK and Ireland to online, Irish retail and some phone customers. For example, if a bet starts at 3/1 and the odds fall to 2/1 when the race starts, Paddy Power will still pay 3/1 on the winner. The promotion suggests times are tough for bookmakers. It may entice punters to keep betting but the offer will drive down gross win margins (the amount of money left over after paying out winning bets).

Shares in Paddy Power hit a 19-month low of €16.15 at the start of the week. The market has been concerned about a decline in consumer spending hurting leisure companies and news of a shrinking Irish economy has accelerated the rate at which Paddy Power’s stock has been falling. Adding to its woes was last week’s news rival operator Ladbrokes is struggling in Ireland. Its half-year results showed gross win in the country falling by 4.4% and costs rising by 5.7%.

Next week’s interim figures may show solid trading but analysts are expected to downgrade earnings forecasts for 2009 in light of the fragile market and potential margin dilution. This could further depress shares in the bookmaker.

Stockbroker Davy did not even wait for the results to be published before marking down its estimates. It says Paddy Power has a good chance of beating half-year forecasts but the price war means future earnings will come under pressure. On Monday (18 August), Davy reduced its 2008 and 2009 earnings per share forecasts by 3% and 10% to €1.44 and €1.37 respectively.

The form guide

There has been a reversal of fortune for Paddy Power. Its share price increased by 115% to €28.55 between August 2006 and October 2007. After a stumble down to €18.35 by January 2008, the stock jumped back to €24.25 in May before starting the current decline. The company has developed a strong brand in the gambling sector and expanded beyond Ireland to build a network of UK high-street betting shops.

Over half of operating profit comes from online operations, where it offers a wide range of services including a sportsbook, poker and financial spread betting.

House broker Investec believes like-for-like revenue growth in Ireland is slowing from the historic 3% to 5% range. It thinks this will be offset by strong online trading. At the AGM in May, outgoing chairman Fintan Drury said the first 20 weeks of the financial year saw ‘favourable sporting results and top line growth’ more than offset ‘adverse’ foreign exchange movements. The market will seek reassurance this trend has continued.

The sharp drop in Paddy Power in the past few months has left its shares trading on a more reasonable PE, having dropped from 15.5 in April to 10.8. On a long-term basis the business still looks attractive but from a trading perspective the shares will remain under pressure until market conditions improve.