Downward revisions of earnings for Macau casino companies amid the United States-China trade war have probably reached a bottom, but industry fundamentals are still in place, making potentially an attractive entry point for investors in the stocks, suggest several brokerages.
“We think even the ‘bears’ would agree that the investment thesis for Macau has always been about ‘structural growth of mass’ and ‘abundant cash-flow’ – and that both stories remain intact, if not enhanced,” said a Wednesday note from analysts DS Kim and Christopher Tang of JP Morgan Securities (Asia Pacific) Ltd. They were referring to mass-market gambling versus the high roller kind. In the first quarter this year, VIP gambling gross gaming revenue (GGR) declined 13.4 percent year-on-year while mass GGR went up 16.1 percent.
“We see earnings revisions to have bottomed and a few companies (Sands [China Ltd] and SJM [Holdings Ltd]) are seeing positive earnings revision,” stated Praveen Choudhary, Thomas Allen and Dan Xu of the Morgan Stanley banking group in their Wednesday memo.
Morgan Stanley thought the current quarter – which it believed could see a sequential 2 percent shrinkage in Macau casino firms’ earnings before interest, taxation, depreciation and amortisation (EBITDA) – might actually be a good entry point for investors, with Macau firms’ EBITDA likely to grow by 3 percent quarter-on-quarter in the three months to September 30.
“…we note that in the past Macau stocks have usually underperformed in the second quarter, but outperformed in the third quarter, thus could provide a good entry point,” wrote the Morgan Stanley team. “This along with high free cash flow-to-equity yield (8 percent), strong balance sheet (less than 1x net debt/EBITDA) and high dividend yield (more than 4 percent) should make the industry defensive,” stated Mr Choudhary and his colleagues.
“Industry valuation is attractive at an estimated 10.4x 2019 and estimated 9.1x 2020 in enterprise value/EBITDA terms, compared to the long-term (last-eight-years) average of 12.5x,” the Morgan Stanley team added.
Power of the mass
JP Morgan expected the Macau industry to have discretionary free cash flow of “US$7 billion to US$8 billion” per annum in 2019 to 2020, which was “equivalent to nearly one-fifth of industry GGR” and already larger than the size of net debt at an “aggregate of US$5.6 billion” at end of 2018.
JP Morgan thought mass-gaming GGR this year will be “+12 percent”, compared to a previous estimate of “+4 percent”. Morgan Stanley has raised its 2019 mass-growth forecast from “7 percent” to “10 percent”. That would be supported by strong growth in tourism to Macau thanks to better transport links, notably the Hong Kong-Zhuhai-Macau Bridge across the Pearl River Delta.
Speculation about what will happen when the current six Macau gaming permits expire has on occasion spooked Macau investors. But with all six operators now on the same finish line – June 2022 – and no fresh news on the retender topic likely for the next 24 months, licence-associated risk during that two-year period was likely to be “minimal” said Morgan Stanley.
“We expect the renewal/rebidding process to start only in 2021,” noted the institution.
“Despite concerns on this front, we expect smooth renewal for all existing casino operators due to land leases extending beyond gaming licences and as each of the operators fulfills its duty of encouraging small and medium-sized enterprises, and local employment and advancement opportunities.”
Nonetheless “valuation multiples could remain depressed” until the concession issue was resolved, which “could take a long time,” the Morgan Stanley analysts noted.
Other Macau market risks included a reduction in the value of China’s currency on world markets amid trade tensions, and thus a fall in the spending power of Chinese gamblers and consumers. Macau casino bets are generally denominated in Hong Kong dollars, a currency pegged against the U.S. dollar.
“We expect China’s GDP [gross domestic product] growth to slow down due to trade tensions, which could cause [Macau] GGR to turn down in the near term,” said Morgan Stanley.
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Macau’s total VIP gross gaming revenue in the first quarter of 2021