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Why I won’t be backing Ladbrokes Coral Group plc despite its low P/E

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Shares in freshly-merged bookmaker, Ladbrokes Coral (LSE: LCL) climbed almost 4% this morning as the company released a fairly positive statement on trading. Should investors now see the company as an investment horse worth backing?  Not in my opinion.  Here’s why.

Decent form

Perhaps the biggest highlight from today’s update related to its digital offering. Given how vital it is for most companies — particularly those in the gambling industry — to provide customers with a quality online service, investors will be comforted by the 18% rise in net revenue during the last quarter (from the start of October to the end of December).  When looked at separately, net revenue from was 17% up compared to last year. Coral’s equivalent revenue also rose, by 13%.

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Elsewhere, multi-channel sign-ups across both companies “remained strong” with 140,000 customers signing up to the Connect card or Grid service. Given the benefits that come from geographical diversification, a 45% jump in net revenue from Ladbrokes in Australia was also very encouraging.  

It wasn’t all great news. UK net revenue dipped 4% compared to the same period in 2015. Like-for-like over-the-counter stakes also fell 5%. Nevertheless, full-year proforma operating profit at the group is now expected to be in the range of £275m-£285m, with Ladbrokes standalone operating profit around £101m and Coral Group standalone profit in the ballpark of £179m. The former is in line with the market consensus; the latter in line with management expectations. This compares favourably to operating profit of £235m in 2015.

Signing-off the update, CEO Jim Mullen hailed an “encouraging start” for the new company, even if “the sporting gods” did not give Ladbrokes Coral quite the results it was looking for in this trading period. 

Temptingly cheap? 

At the time of writing, shares in Ladbrokes trade on a price-to-earnings (P/E) ratio of just over 11 for 2017, based on a predicted 47% rise in earnings per share. Ordinarily, any stock releasing a fairly positive update on this valuation would seriously grab my attention. Not so much here.

While the gambling industry has shown itself to be rather resilient in times of economic uncertainty, there’s no escaping the fact that it remains susceptible to political meddling. Only last month, it was reported that a cross-party group of MPs were demanding that the maximum stakes on fixed odds betting terminals should be drastically reduced, from £100 to £2, to minimise the possibility of heavy losses and “societal harm“. Given the huge estate operated by Ladbrokes Coral, any new legislation announced by the government could have a massive impact on profits and see its shares plummet. Is that a risk worth taking? With so many other opportunities in the market, I’m not so sure.

Although not immune to developments in this hyper-competitive industry, I think peer GVC (LSE: GVC) — with its focus on online and mobile services to other businesses as well as punters — might be a better bet for those still drawn to gaming and betting stocks. Shares in the £1.8bn cap owner of brands such as Foxy Bingo and bwin have sprinted ahead of the competition over the last 12 months, rising 33%. With earnings per share expected to shoot up by over 70% this year, there could be more upside ahead. So long as this happens, a P/E of 12 for 2017 seems reasonable. A well-covered, forecast yield of over 4% is also likely to appeal to income-chasing investors. 

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended GVC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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