Magnum reported an underwhelming set of results with net profit falling by a whopping 56% YoY to only RM30.6m in 1QFY17 owing to intense competition from illegal operators, weak consumer spending and a higher prize payout ratio. The results only accounted for 15% and 14% of our and consensus full-year estimates respectively. 1Q has traditionally been the strongest quarter seasonally due to the Chinese New Year effect but the current quarter has turned out to be the weakest in recent years. We cut our earnings forecasts for FY17-19F by 6-26% to factor in higher costs and prize payout ratio. We have rolled forward our DCF valuation to FY18F and adjusted down our terminal growth assumption from 1.5% to 1%. As such, our TP is reduced from RM2.35 to RM1.70. For the first time, no quarterly dividend was declared. We cut our dividend payout ratio from 95% to 80%, which translates to a yield of 4%. Also, given the uncertainties with regards to a material litigation between Magnum and the Inland Revenue Board for tax penalty amounting to RM476.5m, we downgrade Magnum from Neutral to Underperform.

• 1Q17 revenue (-7.4% YoY, 9.9% QoQ). Due to intense competition from illegal gaming operators, weak consumer sentiment and having one less draw, Magnum’s 1Q17 revenue was down 7.4% YoY to RM697.1m. However, it delivered higher revenue QoQ due to stronger ticket sales during Chinese New Year festival.

• 1Q17 net profit (-55.6% YoY, -32.2% QoQ). Unexpectedly, net profit fell sharply by 55.6% YoY on lower sales and higher prize payout ratio. As a result, we cut our earnings forecasts for FY17F, FY18F and FY19F by 25.8%, 9.2% and 5.8% respectively, after factoring in the impact of poor luck factor and higher cost.

• Material litigation with the Inland Revenue Board. Magnum also announced that it was served with notices of assessment for a total tax penalty amounting to RM476.5m for assessment years 2008 to 2011. This was pursuant to the disallowance of the deduction of interest expense and loan stock interest expenses incurred during the said years. Upon consulting its solicitors, management is of the view that there are reasonable grounds to challenge the validity of the notices raised by the Inland Revenue. There will be no imminent financial effects pending resolution of this matter though this is likely to cast a large overhang on the shares in the interim.

Source: PublicInvest Research - 22 May 2017