There are “three conventional wisdoms” about the Macau casino market that need to be challenged if investors are to gain a holistic view on the stocks of the city’s gaming operators, says a report from Japanese brokerage Nomura.
It says the three “wisdoms” are: that there is little risk of disappointment regarding mass market demand for gambling in Macau; that there is no balance sheet risk to the Macau operators; and that the most effective way of analysing the pricing of the Macau operators’ stock is using in each case the calculation of enterprise value (EV) over earnings before interest, taxation, depreciation and amortisation (EBITDA).
“While our mass gaming growth forecast of 9 percent in 2016 full year is already close to the lower-end of the consensus forecast range, we believe there could still be risk of disappointment, with our concern stemming from three deteriorating macro trends: declining lottery sales in China from 2015; a depreciating renminbi [Chinese currency] (down 10 percent in the past two years); and declining Chinese visitation (down 4 percent year to date to November 2015 [the most recent data], with more severe declines from Shanghai and Beijing at -9 percent and -13 percent,” stated Tuesday’s report.
Brokerage Sanford C. Bernstein Ltd nonetheless said in a note on Monday that 2016 was likely to be “a year of inflection” for Macau, with mass-market gambling resuming growth.
Balance sheet stress
Regarding the potential for balance sheet risk for Macau operators, Nomura notes that “the U.S. is entering an interest rate up cycle,” potentially increasing interest payable on project loans issued under the Hong Kong Interbank Offered Rate (HIBOR) system. The Hong Kong dollar’s exchange rate on international markets is pegged to that of the U.S. dollar.
The Japanese brokerage referred as an example to the debt raised to build the US$4.1-billion Wynn Macau Ltd’s Wynn Palace resort, which is due to open on June 25.
“The build out of Wynn Palace is bringing Wynn Macau’s balance sheet to relatively risky levels, as we forecast the company’s net debt to EBITDA to reach 2.4x to 4.5x in 2016-17… Interest coverage is also expected to hit 2.8x to 2.9x in 2016-17… exposing the company to future interest rate risks as most of the interest is HIBOR-linked,” stated Nomura.
The brokerage also referred to MGM China Holdings Ltd’s MGM Cotai project. In August, MGM China said the HKD24-billion (US$3.1-billion) scheme remained “on schedule” for a fourth quarter 2016 opening. The quoted budget excludes land costs and capitalised interest.
“The build-out of MGM Cotai is bringing the balance sheet to relatively risky levels, with net debt to EBITDA expected to reach 2.7x to 4.2x in 2016-17,” said Nomura.
Regarding the third “conventional wisdom” – judging stock price by EV/EBITDA – the report said: “it fails to reflect the sector’s significantly crippled earnings flow-through”.
Referring to the recent earnings cycle at Genting Singapore Plc, operator of the Resorts World Sentosa casino resort in Singapore, report authors Richard Huang, Stella Xing, Harry Curtis and Kelvin Wong noted: “We saw a structural decline in Genting Singapore’s EV/EBITDA since mid-2014, and we expect the same to happen in Macau. We encourage investors to take a more holistic approach to assess industry valuations by focusing not only on EV/EBITDA, but also price to earnings, free cash flow yield and dividend yields.”
The brokerage recommends “investors focus on defensive stocks with high dividend yields, like Sands China [Ltd]”, noting that “95 percent” of EBITDA at Sands China came from “non-VIP sources”.
Sanford Bernstein’s analysts Vitaly Umansky, Simon Zhang and Bo Wen said in their Monday note: “We remain more inclined towards Sands China (due to mass dominance, critical mass on Cotai and focus on return of capital) and Melco Crown [Entertainment Ltd] (largely stemming from outperformance in premium mass and the Studio City project).”
The Sanford Bernstein team had said in a note on Friday that valuation levels for Macau casino names “have become attractive (especially for longer-term investors) and we believe 2016 will be an inflection point with growth in mass gross gaming revenue and non-gaming revenue with stability in margins”.
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