Investors who took a flutter on bookies in 2016 have made a losing bet. The William Hill(LSE: WMH) share price is down 16% over the past 12 months. Paddy Power Betfair(LSE: PPB) is 20% off its year high of 10,850p, trading at 8,665p today. Yet one of these looks like it could be a hidden winner to me.
Paddy Power Betfair is the big boy among the bookies: its market cap of £7.25bn dwarfs William Hill's £2.55bn. My worry is that its valuation also looks somewhat outsize, as it now trades at 29 times earnings, although its yield is a respectable 3.62%. To be fair, the business continues to grow strongly, with Q3 revenue up 25% to £404m, helped by the weaker pound boosting the value of its US and Australian earnings, with the growth rate falling to 15% in constant currency.
It was helped by a strong conclusion to Euro 2016, with sports book stakes up 26%, or 14% in constant currency. Underlying operating profit was up 68% to £95m. Despite this, investors have cooled on the "multi-brand, multi-channel, multi-jurisdictional platform" with its share price down almost 15% in the past three months.
Investors are reacting to signs Prime Minister Theresa May may act on public concerns and biff the bookies. Government ministers have ordered a review of 'crack cocaine' fixed odd betting terminals, which are said to be responsible for at least two suicides. The review is also looking at the advertising of betting sites on TV, which is wall-to-wall in Premiership matches. With an estimated 600,000 UK gambling addicts, action is likely. Paddy Power Betfair's high profile (and high valuation) could make it particularly vulnerable.
William Hill will also get caught up in any crackdown, but its lowly valuation of just 11.82 times earnings reduces the chances that you're overpaying today. Its dividend yield of 4.25% is also attractive. The latest trading statement showed full-year operating profit at the top end of guidance at between £260m-£280m, and it has also identified £30m in cost savings. Revenue rose 4% in the 17 weeks to 25 October, helped by an 11% rise in online revenues, which offset disappointing activity levels in its shops.
Quite a gamble
Analysts expect further gambling sector consolidation, and although William Hill has abandoned merger talks with Canadian online gaming group Amaya and rejected a three-way merger proposal from 888 Holdings and Rank Group, further opportunities may arise.
You need to understand the risks of investing in any gambling stock right now. An aggressive government review could top slice share prices across the sector at a single stroke. Some of this is priced in, but not all of it. William Hill still looks tempting, as it expands deeper into overseas markets, and explores potential for growth in mobile wagers. Paddy Power Betfair has shown there are strong growth prospects in this sector, but William Hill may be better placed, as it has more scope to play catch-up. It's a gamble though.
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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended Paddy Power Betfair. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.