We downgrade our rating on the gaming sector to Neutral from Overweight, after the 2019 budget given the increase in various duties and licensing fees, which are likely to have a negative impact on the sector’s profitability. Although the magnitude of the impact is hard to quantify, we have taken a conservative approach by assuming a reduction in top line similar to the hike in the tax rate, which leads to an overall reduction in our sector earnings by 9% for 2019-20E. Genting Berhad remains our top sector pick on valuation grounds.

Malaysia Has Second-highest Gaming Tax in Asia

We believe that with the increase in gaming tax (1. Casino license to be increased by RM30m per annum; 2. Casino duties to be lifted to 35% from 25%; 3. Gaming-machine duties to be raised to 30%; 4) Machine-dealer’s license to be increased to RM50k per annum; and 5. The number of special draws to be halved), Genting Malaysia (GENM) is likely to be less competitive relative to its Asia peers, as Malaysia has the second highest casino duties just behind Macau. GENM will likely need to sacrifice some margins in the VIP and Premium Mass segment in order to protect its market share, as casinos with lower tax rates are able to offer higher rebates and other complimentary services. We are expecting some gaming volume contraction due to the higher duties. As such, we are downgrading GENM to HOLD (from BUY) and Berjaya Sports Toto (BST) from to SELL (from HOLD). We reiterate our BUY call on Genting Berhad (GENT).

Negative Impact Goes Beyond Earnings

The increase in duties and fee will likely not only negatively affect gaming company earnings in Malaysia, but also the valuations of these companies. As there is no certainty as to whether this is a one-off hike (or recurring one in years ahead considering the last tax increase in the sector came in 2005), we are of the view that the risk perception for the gaming sector will be higher than before. Gaming companies might also be reluctant to invest more capex into their current operations, as it might take longer than expected for them to achieve the desirable returns.

Downgrade to Neutral, Following Our Downgrades to GENM and BST

We are downgrading the sector to Neutral from Overweight, after the announcement of the budget, as we believe that the hike in various gaming duties and licensing fee will lower sector profitability. We are cutting our sector 2019-20E EPS by 9% after incorporating the changes. We now look for sector earnings to grow at a slower pace of 0.3%, from 9.9% previously, over 2018-2019E. Sector upside risk: higher-than-expected volume growth in the VIP segment; downside risk: weaker-than-expected visitor numbers.

Source: Affin Hwang Research - 5 Nov 2018