By Zandile Nkwanyana
The leisure industry is at an exciting inflection point with growth likely to be supported by a stronger consumer, growth of online gambling and the continued recovery in tourism.
Looking ahead, the macroeconomic environment continues to improve with several tailwinds supporting consumption. Interest rates are coming down as inflation remains within the lower end of the South African Reserve Bank’s targeted range.
There is also more optimism around the growth outlook as loadshedding has significantly reduced and business confidence improves. This should support job creation. The spending of withdrawals from the two-pot retirement system should be a further boost for consumers.
We also believe the market may be underestimating the potential growth of online gambling in South Africa. The sector boomed during the pandemic, and we have continued to see increased player activity and penetration. The industry has grown at a CAGR of around 20% from 2010 to 2023 and is still dominated by private and international players.
The listed leisure companies have finally entered the race with meaningful investments that are already showing positive traction. Their current low market share (less than 5% combined) shows the potential for more growth in this area. Online gambling is an attractive industry as the model is highly scalable and capital light when compared to traditional leisure business models.
The leisure industry has performed well despite the sluggish recovery in the South African tourism industry. Management teams emerged from the pandemic with much leaner businesses and more disciplined capital allocation. They have navigated the challenging backdrop well by implementing cost cutting programs and using excess capital to repurchase shares at attractive levels.
The recovery in tourism should support their leaner structures with growth that goes straight to the bottom line. Domestic tourism has already surpassed 2019 levels while foreign tourism will recover along with the global economy, with a rebound expected by 2025. We think further growth will be supported by new travel routes and government policy. The sector is a critical contributor to gross domestic product growth and a priority for Operation Vulindlela, a partnership between the Presidency and National Treasury that supports critical policies to accelerate structural reform.
Many of the companies in the leisure sector are now small and mid-caps. These “SA Inc.” stocks have experienced a remarkable rally since this year’s election outcome and formation of the Government of National Unity.
Most of this rally has been driven by multiple expansion. From here, our team is focused on finding companies with earnings growth that can drive share prices higher. We believe that the local leisure stocks are still quite relatively attractive at these levels, with earnings visibility as they benefit from increased discretionary spend and two sector themes – higher online gambling penetration and growing tourism. Strong balance sheets will also support shareholder returns going forward.
Sun International: Strong growth from industry consolidation and online gambling
Sun International’s portfolio has more exposure to gaming, with lodging a complement to these core operations. The company is currently acquiring Peermont, which will make it the largest casino group in South Africa. This is a sound strategic decision by management that uses the strong balance sheet to acquire a highly cash generative, complementary asset.
The land-based casino portfolio will support the group’s investment in higher growth areas (such as online gambling) and return to shareholders in the form of dividends. Sunbet, the group’s online gambling division, has ambitious plans to grow market share from the current 3.7% to over 10% by 2028. The operations are already highly profitable with strong customer retention and high brand value which make these targets feasible. On the lodging side, the company’s recently renovated Table Bay Hotel (in Cape Town) is likely to a meaningful contributor to growth going forward.
Tsogo Sun: Highly profitable and cash generative
Tsogo is a pure gambling play with a still nascent exposure to online gambling. The company’s portfolio (through assets such as Monte Casino) has exposure to increased spend on entertainment and experiences, which have remained a focus of discretionary spend post Covid-19. The company is highly cash generative with a strong balance sheet that should support further shareholder returns.
Southern Sun: Best in class hotel portfolio and buyback support
Southern Sun has a regionally diverse hotel portfolio with exposure to the strong Cape Town tourism market and will be a beneficiary of any improvement in tourism in other regions. The company is run by an impressive management team of strong operators. A sound capital allocation strategy has seen the company return excess cash to shareholders in the form of buybacks, taking advantage of the cheap valuation.
Zandile Nkwanyana is an equity analyst at 36ONE Asset Management and part of the PPS Managed Fund investment team.
BUSINESS REPORT