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Chairman and Chief Executive Officer's review



The group continued to pursue its growth strategy through the weak economic environment and remains highly cash generative. Trading, particularly in the fourth quarter, reflected good growth on the prior year, although the sustainability of this performance will depend on how the economy performs going forward.


Overview

The 2016 financial year delivered a pleasing growth of 12% in adjusted headline earnings per share, with much of this growth being delivered in the second half of the year. In particular, a strong fourth quarter gaming performance at Montecasino and Gold Reef City and a good summer trading period in hotels assisted this achievement.

As discussed in our prior year report, the 2015 financial year included a number of anomalies that were not repeated in the 2016 financial year, including the closure of Southern Sun Maputo for a number of months in the prior year to be refurbished and expanded. Government travel posted an element of recovery during the 2016 financial year after a very strong reduction in the prior year, and while substantially off its historical levels, continues to show some improvement. Importantly, a new pricing framework has been agreed with national treasury which should result in growth in the government segment for the group and offer value to government departments as customers going forward.

A number of the projects that the group has been working on began to deliver value during the 2016 financial year. Both the Silverstar and Gold Reef City redevelopments are now substantially complete and have been well received by the relevant markets. Growth in gaming win at Silverstar has been somewhat disappointing since the relaunch and some changes to the offering are being made to try to improve performance. Gold Reef City has seen a substantial increase in gaming revenue since the redevelopment and the product appears to suit the target market well. In addition, the Gold Reef City Theme Park experienced a record trading year, and the Apartheid Museum is enjoying the benefits of the new exhibition space that was provided as part of the overall project.

The full effect of the R2.8 billion share buy-back undertaken as part of the SABMiller exit is now in our base, with a fully diluted weighted average number of shares at year end at 957 million, some 5.6% down on last year and 12.8% down over two years.

The dividend of 98 cents per share for the year represents 10% growth on the prior year and a 14% compound growth in dividend since listing in 2011, despite a difficult macro-economic environment. This speaks to the relative resilience of the gaming industry, the recovery of the hotel industry from the lows of the recession and the activities undertaken at Tsogo Sun, both through expansionary investments and operational efficiencies.

As always, regulatory challenges continue to present risks to the group and we remain vigilant to these. These challenges are as varied as changes in BBBEE regulations, gaming, corporate and personal taxes, FICA-related rules and visa regulations, which have significantly impacted tourism to South Africa from the global growth markets of India and China. We continue to engage with government to try and ensure the impacts of proposed policy changes are understood and analysed before they are implemented.

Looking forward, there are three material projects on which the group is focused:

  • the conclusion of the acquisition of a controlling stake in the Hospitality Property Fund. This vehicle has been identified as the ideal Real Estate Investment Trust (‘REIT') structure in which to house the majority of the group's hotel property assets while simultaneously allowing the acquisition of a further 16 hotel properties managed by a variety of operators. This acquisition will be concluded during the second half of 2016;
  • the expansion of the Suncoast Casino in Durban through the addition of 20 000 square metres of retail space and a substantial expansion and refurbishment of the casino. The size of the retail space has been reduced from a previously planned 50 000 square metres to reduce the potential for negative construction-related impacts on the existing casino and to enhance the return on the expansion through the elimination of excessively expensive parking requirements. The total project is now estimated at R2.1 billion, with construction expected to begin during September 2016; and
  • the relocation of one of the smaller casinos in the Cape province to the Cape Town Metropole. Consultations have been held with the provincial authorities in this regard and progress in the regulatory process is anticipated during 2016.

Independently of the relocation exercise, Tsogo Sun acquired a 20% stake in the Grandwest and Worcester casinos in the Cape region. The R1.35 billion acquisition (including interest) increases the group's exposure to the Cape provincial gaming spend by some 16pp. The investment is a passive one for the group, as Sun International continues to operate the casinos, but should prove to be a lucrative one, as the Cape Town economy continues to grow.

  • Major acquisitions

    1. F'10

      1. 30% of Suncoast (R1.0 billion)
      2. Century Casinos (R438 million)
    2. F'14

      1. 10% of Suncoast (R400 million)
      2. 75.5% of Southern Sun Ikoyi (R695 million)
    3. F'11

      1. Gold Reef merger
    4. F'15

      1. 10% increase in interest in Cullinan and acquisition of hotel assets (R762 million)
      2. 25% of Redefine BDL (R145 million)
      3. Buy-back of 12% of Tsogo Sun ordinary shares (R2.8 billion)
    5. F'12

      1. 16.5% of Suncoast (R510 million)
      2. 52.6% of Hotel Formula1 (R300 million)
    6. F'16

      1. 25% of International Hotel Group Limited (R315 million)
      2. 55% of HPF B-linked units (R252 million)
      3. 20% of the Grandwest and Worcester casinos (R1.35 billion) (Post year end)


Strategic priorities

The strategic priorities of the Tsogo Sun group remain sustainability and growth. Given the uncertain macro-economic outlook in South Africa in the short to medium term, sustainability is never far from mind. We have successfully continued to firstly avoid mistakes that can threaten the survival and health of the business and secondly, identify external risks and opportunities and then develop mitigating strategies to minimise or eliminate the impact of the risks on the organisation and strategies to take advantage of the opportunities. Growth is achieved both organically and inorganically and is measured by the increase in the group's free cash flow generated over time.

Sustainability

Sustainability for Tsogo Sun is about the five major pillars of focus for ensuring the long-term survival and prosperity of the group. We continue to focus on and make good progress in each of these areas.

Financial strength and durability
Closing net debt to Ebitdar at 2.0 times remains comfortable and net debt remained stable at R9.2 billion. The group's committed debt facilities total R14.3 billion, some R4.8 billion above the current drawdown (including available cash on hand), and have an average tenure of just over four years. Accordingly, the group is adequately funded for ongoing operations and macro-economic shocks that may occur and can take advantage of significant expansion opportunities.

Debt is expected to increase with the conclusion of the acquisition of a controlling stake in the Hospitality Property Fund, the Grandwest and Worcester minority investments and the expansion of the Suncoast Casino as discussed above, but the ratio of net debt to Ebitdar is not expected to materially exceed 2.5 times.

Deliver to our beneficiaries
Given the perceived social impacts around gaming, it will always be important who owns us and who enjoys the economic benefit of the group's activities through dividends, employment, taxes and social programmes.

During the 2016 financial year, the group continued to enjoy a stable and supportive shareholder in HCI, with the ultimate largest shareholder through HCI being SACTWU. HCI continues to show a significant amount of support and enthusiasm for the group's growth strategy and this has played a material part in assisting us to close a number of beneficial expansion opportunities.

In the prior year, the group consolidated its CSI and enterprise development activities under the concept of Citizenship. R52 million was spent on CSI initiatives in the key areas of education, sport and environmental awareness, while in supplier and enterprise development the Tsogo Sun Entrepreneurs programme now supports 180 emerging businesses in the tourism sector and other industries throughout the country. As a group we have tried to focus on programmes that make a real difference in the communities we operate in, with the initiatives often coming from staff at the unit level.

The R30 million expansion of the Apartheid Museum as a voluntary addition to the Gold Reef City refurbishment project will help this important institution continue with and expand its activities.

With almost 23 000 people directly and indirectly employed by the group and R2.2 billion in direct taxes paid per annum, it is clear that the benefits of the group's activities are enjoyed through a large and diverse stakeholder base. We refer you to the value added statement in the key relationships section on page 26 and the community section on page 39 for further information.

Our 2016 BBBEE rating has been reaffirmed at level 2 under the Revised Codes of Good Practice – tourism sector scorecard. This was the result of a significant effort to focus on all areas of the business and an operating philosophy that ensures the BBBEE impacts of each decision the business makes are taken into account. There continues to be significant uncertainty as to what the group's BBBEE rating will be under the new codes going forward as a result of the uncommercial nature in which they have been drafted, particularly with regard to the subminimum demotions and the change in scoring scales and will be impacted by, for example, the outcome of key suppliers' revised ratings in years to come.

The group continues to litigate against attempts by various gambling boards to unilaterally impose the achievement of defined levels of empowerment, as measured against the codes, as an arbitrary licence condition due to the uncertainty and the extent to which the levels achieved are moved out of the group's control. We remain committed to enhancing the group's BBBEE credentials in every commercially reasonable way, but cannot expose our licences to regulatory risk against uncertain moving targets.

Product relevance to customer experience
Tsogo Sun continues to reinforce its position as an established household name, in both the corporate and consumer markets in South Africa. The essence of the group's products remain onsite experiences, as, in order for our customers to consume our product, they need to physically visit our properties, be it for theatre, entertainment, dining, gaming or hospitality.

After a number of years of intense focus, the majority of the group's properties are substantially refurbished and in excellent condition. The last year alone has seen the refurbishment of the Sandton Sun, Riverside Sun, Sabi River Sun, Garden Court Kings Beach, Garden Court Polokwane, StayEasy Century City, Golden Horse Casino, Mykonos Casino and Gold Reef City Casino.

During the 2016 financial year, the group launched its new website tsogosun.com which has been totally redesigned to ensure search engine optimisation. A special mention goes to the HeBS Digital team from the United States who were instrumental in this project and were nominated as an official honouree in the 20th Annual Webby Awards for the Tsogo Sun website. A new booking engine with specific focus on mobile booking was launched during August 2016. With over 60% of hotel bookings being made direct to the properties, the call centre capability and web/mobile- based accessibly of the group are critical strengths and continue to receive dedicated focus.

We again invested in excess of R300 million in the replacement and upgrade of our casino equipment during the 2016 financial year. While this equipment is procured ‘off the shelf' we spend significant time working with suppliers, investigating, developing and testing new gaming technologies before deploying them to our operations. As mentioned last year, we have upgraded all our gaming management systems to either IGT Advantage or Gamesmart and these are operating well.

Regulatory compliance
The group enforces a culture of compliance at all levels of the organisation, relating to all relevant laws and regulations. Compliance is not limited to intensive gaming regulatory requirements, but also involves having systems and review processes in place to understand and abide by laws in areas as diverse as liquor and fire regulations, health and hygiene standards, labour, competition and consumer practices.

While we respect the important role that the various regulatory bodies play in society, business in general and towards the affairs of the group specifically, we have been, and are still, forced to challenge arbitrary unjustified decisions and laws and regulations that we believe are misguided or will have unintended adverse consequences for the group and its stakeholders. We will continue to defend our commercial rights while maintaining a cordial and cooperative relationship with various levels of government.

Human resources
Tsogo Sun aims to recruit staff with the best skills and attitudes available and provide an enabling and positive work environment. The Tsogo Sun Academy, which controls all aspects of the group's employee training and development programmes, is a significant asset to ensure staff are properly equipped for the work environment with R123 million spent during the 2016 financial year on training. We firmly believe that engagement is often as important to derive the best performance from a workforce as are the levels of remuneration.

We have also focused on nurturing talent at the tertiary education level and have a number of programmes in place to bring students, artisans and apprentices into the group during their training phases. We recognise that as the leading hotel and gaming group we are a source of trained labour to most other companies in the industry, but accept this responsibility as part of our contribution to the growth of our industries in the country and by identifying talent early we hope to retain the pick of the crop for ourselves.

The remuneration report on page 71 to page 76 highlights the group's philosophy towards remuneration and incentivisation, ensuring we retain valuable talent.

Growth

The value of a business is the present value of the cash flows that can be generated by the assets and other capitals utilised by the business. Accordingly, the only true measure of growth for our business over time is its growth in free cash flow.

Our free cash flow increased by 8% to R2.0 billion for the 2016 financial year despite the increase in maintenance capital expenditure including the projects referred to above. The coming year should see growth in free cash flow as we grow cash generated from operations and acquire new businesses.

Organic growth
In gaming, the macro-economic environment remains subdued and consumer sentiment remains poor. This is not expected to materially change in the short to medium term. The gaming win growth of 6% was impacted by a slow performance in both slots and tables in the first nine months of the year, but accelerated in the last quarter. The increase in growth in gaming win has continued into the new financial year, however, it is too early to call it a change in cycle. A feature of the growth is volatility, both within specific casinos from month to month and between various regions. On the positive side, the results clearly indicate the significant potential of the group to generate substantially higher cash flows as revenue accelerates.

In the South African hotel division, overall owned occupancies at 61.9% increased by 0.7pp and are still well below normal long-term levels of around 68%. Overall transient corporate and government business, groups and conventions, local leisure and international visitors have all shown an improvement in the 2016 financial year, particularly in the second half of the year. The group has put substantial effort into refining its revenue management approach to ensure we are charging the right rate for the right room on any given day. These include pushing more contracted business towards a variable ‘Best Available Rate' strategy, incorporating a new rate segmentation model and deploying rates management technology where applicable.

It appears as if the local hotel industry is showing overall structural improvement in demand as many operators have been reflecting improved trading results and the improvements have covered all key regions. A word of warning, however, is that hotel trading is notoriously volatile on the upside and downside.

The group's Africa hotels excluding South Africa reflect significantly higher earnings as a result of the closure of Southern Sun Maputo in the prior year not being repeated. However, this has masked an underlying significantly weaker trading environment in many of our African markets. The theme is consistent, as the local economies have been heavily impacted, either directly or indirectly, through the collapse in commodity prices and the consequential collapse in local currencies. Despite this gloomy picture, we remain satisfied with our investments in these destinations and will seek to deploy more capital in this regard where the investment case is compelling.

The group's financial results for the 2016 financial year reflect income and Ebitdar growth of 8% on the prior year assisted by the acquisitions implemented in the prior and current year. Improved operating margins should be achievable if revenue growth continues at current trends.

Tsogo Sun stands to benefit significantly from the high levels of operational gearing in the industries in which it operates and should see a significant increase in operating cash flows if organic revenue growth, even marginally above inflationary levels, can be sustainably achieved. We maintain this position and continue to build on this asset base where possible.

Inorganic growth
Inorganic growth is pursued through a combination of expanding our existing facilities, new developments and acquisitions. The group invested R962 million during the 2016 financial year in acquiring hotel businesses and expanding hotel and casino properties. For detail of the transactions refer to page 60.

The group continues to pursue additional opportunities with the most significant being the Hospitality Property Fund, the Suncoast expansion and the Western Cape relocation discussed above.

In addition, a number of other initiatives continue to be pursued, including:
  • the group's non-hotel and gaming-related property portfolio continues to grow as we roll out the second phase of Monte Circle at Montecasino and continue to evaluate various land and property holdings and development opportunities;
  • the potential for the fourth casino licence to be issued in Mpumalanga, which is currently tied up in a legal process;
  • the 25% investments in Redefine BDL Hotel Management Group and International Hotel Group Limited, totalling some GBP23 million, which has opened a platform for potential further growth in the UK and European hotel market; and
  • South Africa and the rest of the African continent continue to offer good investment opportunities and these are being pursued.

These opportunities are evaluated by the group with a strong focus on ensuring that we are capable of operating them successfully, that they are priced for value and that they do not impinge on our sustainability.

As we have said before, provided the macro-economy does not go into free fall and that regulatory changes are well considered by the relevant authorities, we remain confident of generating significant value for our stakeholders going forward.

Appreciation

We wish to extend our appreciation to the board, management and the staff of the group for their efforts during the year. In particular, we thank Rex Tomlinson for his contribution to the group as the lead independent director for the past five years. Tsogo Sun remains a group with irreplaceable assets and people.

John Copelyn Marcel von Aulock
Chairman Chief Executive Officer
   
19 August 2016 19 August 2016

uMhlanga Sands