We are downgrading the sector to NEUTRAL as the PER valuation is no longer attractive following the recent surge in GENTING’s share prices. We believe the downgrade is timely given the lack of immediate price/earnings catalyst to propel prices higher. Having said that, NFO players remain as income stocks with their supernormal dividend yield of 6% despite facing depleting ticket sales and poorer luck factor of late. On the casino front, we believe the recent recovery in Macau casino revenues is too early to indicate a similar recovery in the Singaporean market. Meanwhile, a meaningful impact from the redevelopment of Genting Highlands is only likely in 2018. Thus, we see little catalyst for the casino segment for now. Given that the sector is the only sin sector that has not faced any tax hike for several years now, a gaming tax hike is possible but if not properly adjusted could turn out to be lose-lose situation for both operators and the government.

Downgrade the sector to NEUTRAL following recent downgrades of Genting Bhd (GENTING, MP; TP: RM10.04) and Berjaya Sports Toto Bhd (BJTOTO, MP; TP: RM3.42) after the former’s share prices surged strongly while the latter reported a disappointing set of 3Q16 results which was hit by unfavourable luck factor. The sector’s PER valuation is no longer attractive after the run-up in GENTING at 17x CY16 earnings multiplier, which is in line with the market valuation. With the lack of immediate earnings/price catalyst for the sector, we believe the downgrade is timely. However, NFO players remain as income stocks with their supernormal dividend yield of 6%.

Magnum Bhd (MAGNUM, OP; TP: RM2.90) is now the only OUTPEFORM call in the sector while we are SELLers of Genting Malaysia Bhd (GENM, UP; TP: RM4.26). Casino: GENTING took the limelight in 1QCY16. After more than two years of underperformance, GENTING rallied 27% YTD. This could be due to the foreigners buying into laggard stocks coupled with the potential value creation from TauRx Pharmaceuticals. It was reported in January that the pharmaceutical company is planning an IPO in Nasdaq next year with a potential valuation of USD15b, which could be a major catalyst to the group should it materialise. In mid-March, it was quoted in the press that the Singapore-based firm plans to present results from ongoing final human trials on its experimental Alzheimer’s drug, LMTX as early as July. All these are the likely price drivers in the past three months given that the existing businesses, especially the casino business has not been seeing meaningful improvement except higher share prices. In fact, Genting Singapore plc (Not Rated) continued to lose market share to Marina Bay Sands on the back of bleak outlook for high-roller market. GENM’s local operation remains resilient but a double-up in capex to RM10.38b for the hilltop redevelopment program caught everyone by surprise. In addition, the opening of the 20th Century Fox World Theme Park is end-2017, thus any meaningful impact could only feel in 2018.

NFO: high prize payout and depleting ticket sales are the key issues. BJTOTO faced selling pressure after reporting dismay 3Q16 results, which saw its net profit falling to RM58.4m, the lowest quarterly profit in more than a decade since 4Q04 due to high prize payout of 63.5% coupled with lower ticket sales, which prompted us to downgrade the stock to MARKET PERFORM. In fact, this is the 4th straight quarter of unfavourable luck factor, which was higher than the normal theoretical level of 60%. Although the payout ratio was still less volatile than that of MAGNUM, the continued high payout had dented BJTOTO’s bottomline in the past four quarters. Historically, the worst and best payout for MAGNUM was 75% and 60% against its theoretical level of 66% while BJTOTO was at 64% and 57% against the theoretical level of 60%. On the other hand, NFO ticket sales have been declining in the past three years which fell 2%-4% p.a. for both NFO players. Furthermore, there are no signs of any reversal in fortune yet in the past few quarters. The question will be who is the winner? Both NFO players registered lower ticket sales so that the likely scenario will be the crossover to the illegal market. On a positive note, we gather from the unlisted rival Pan Malaysia DaMaCai’s website that it is having 22 special draws in 2016, which is higher than the normal 20 special daws per annum in the past. Should this applies to every player equally, there should be upside in ticket sales this year.

Gaming tax hike? Given the expected decline in oil revenues and the recent excise duty hikes for sin sectors like tobacco and brewery, the gaming sector could be the next sin sector to face a tax hike. In fact, gaming is the only sin sector that did not get frequent tax hike as other sin sectors like tobacco. Our record shows that the last tax hike for the sector was in mid-2010 for the NFO operators only. We believe the sector did not get frequent tax upward adjustment like other sin sectors as the implication of a tax hike could be tricky. This is because a gaming tax hike could be a “lose-lose” situation to both government and the player. This is possible as government may lose out tax revenue should ticket sales decline in the event the players have to lower down prize payout to maintain their profitability, as for every 1% hike in gaming tax could result in a 7%-8% decline in bottomline, making them less attractive to punters who may cross over to the illegal market. Furthermore, ticket sales have been on the downtrend in the past three years coupled with the 6% GST, the players may not be able to absorb any additional tax increases. As such, the authority has to be careful in adjusting the tax. In Jan 2003, the authority standardised gaming tax across the three NFO players by raising pool betting duty at the same time allowing the prize payout to increase. This resulted in higher ticket sales as there was a crossover from illegal market due to attractive prize payout. We believe this could be one of the options to deal with the tax hike. 

Source: Kenanga Research - 6 Apr 2016