Why I’d dump this FTSE 100 growth champion to buy its FTSE 250 peer

Rupert Hargreaves looks at one FTSE 250 (INDEXFTSE: MCX) company that’s taking on its FTSE 100 (INDEXFTSE:UKX) rival.

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Gambling company William Hill (LSE: WMH) is currently one of the cheapest stocks in the FTSE 250. Mixed earnings results, coupled with regulatory uncertainty, have put investors off the shares. However, management is committed to reigniting growth and, as part of these efforts, the group is expanding into the United States. 

Today, I’m going to weigh up the pros and cons of investing in the enterprise as it returns to growth.

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Rising losses 

At the beginning of August, William Hill reported a mixed set of half-year results. Adjusted pretax profit declined 13% to £96.3m. But in many ways, this figure is misleading. The company also reported an exceptional charge of £916m, which pushed it into a pretax loss of £820m. This large write off included £883m associated with the UK government’s decision to cut the maximum bet for fixed-odds betting terminals. 

Of the £916m exceptional charge, £17.2m was associated with the group’s expansion into the US and additional restructuring costs. After stripping out all of these costs, adjusted operating profit on existing operations increased 1%, and revenues rose 3%.

International expansion 

William Hill’s push into the US excites me because this is a market with tremendous potential, as it’s still relatively undeveloped. Today, the company announced it had reached an agreement with Eldorado Resorts to become the exclusive partner “in the provision of digital and land-based sports betting services as well as online gaming.” As a result of this deal, the firm now has a presence in “13 states where sports betting is either legal or sports betting bills are tabled.” 

The blossoming US market should allow William Hill to continue to grow despite problems at home. Estimates vary, but it’s rumoured that $150bn is wagered on sports in the underground market each year across the country. This indicates the size of the opportunity for the gambling group and its peers could be many billions of dollars.

I reckon the market isn’t taking this opportunity seriously enough. Shares in William Hill currently trade at a forward P/E of just 10.4 and yield 5.4%, implying investors are not expecting any fireworks from the business. With this being the case, now could be the time to buy.

Too expensive? 

When it comes to growth, I think William Hill could be a better investment than its larger peer Paddy Power Betfair (LSE: PPB).

The main reason why I reckon Paddy Power’s returns in the years ahead will disappoint is valuation. The stock looks expensive. Shares in the betting company are valued at 15.6 times forward earnings, which makes them 56% more costly than William Hill. This premium earnings multiple leaves no room for error if the business’s growth stumbles.

The company is following William Hill into the US. It acquired renowned daily fantasy sports operator FanDuel in May and is planning a significant expansion across the continent as sports betting becomes more accepted.

In the first half of 2018, the group’s US revenue lept 21% to $79m. Further acquisitions are planned to build Paddy Power’s presence within the region, adding to its existing offering. With cash on the balance sheet of £149m at the end of the last reported period, the firm certainly has the resources to chase new deals.

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Right now, this ‘screaming BUY’ stock is trading at a steep discount from its IPO price, but it looks like the sky is the limit in the years ahead.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Paddy Power Betfair. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.

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