We maintain our NEUTRAL stance on the gaming sector given the dearth of re-rating catalysts over the near term. Within Malaysia, Genting Malaysia remains our Top Pick given its earnings resilience and as its MYR5bn capex for Genting Highlands could propel earnings growth in the long run.

2015 review. 2015 was a year to forget for the gaming stocks under our coverage as the imposition of the goods and services tax (GST) effective Apr 2015 (which the operators have to fully absorb) triggered earnings erosion, while the operating environment remains challenging due to the Chinese government’s relentless push to eradicate corruption. Furthermore, fluctuations in luck factor had exerted further downward pressure on sectorial earnings.

Potential tax hike? Unfortunately, things are not looking much better as we enter 2016. First, there have been speculations that the Malaysian Government could soon re-visit a potential hike in gaming taxes to help boost the nation’s tax coffers. We estimate that the gaming industry contributes an estimated MYR2.5bn-2.7bn pa in gaming-related taxes and an additional MYR800m-950m in typical corporate taxes currently. Every 1% hike in casino tax could potentially erode Genting Malaysia’s earnings by 2.5-3% and Genting Bhd’s (Genting) earnings by 1.5-2.2%. Meanwhile, the potential impact on number forecast operators (NFOs) like Magnum and Berjaya Sports Toto (BJ Toto) would be more profound with earnings erosion of 8-9% for every 1% hike in pool-betting duties.

GITP a long-term re-rating catalyst. While we continue to believe that Genting Integrated Tourism Plan (GITP) would help to boost visitation to Genting Highlands over the long run (management targets 30m visitors by 2020 from 20m currently), we believe earnings accretion will only be meaningful come 2017 upon completion of most of the proposed facilities under its Phase 1 expansion. Our channel checks indicate that the new malls (Sky Avenue and Sky Plaza) could potentially house a new casino with an initial capacity of 50 new gaming tables, which will open its doors to visitors by end-2016. We deem this, coupled with the scheduled opening of the new outdoor theme park by early 2017, the most crucial elements in rejuvenating visitation interest. We will keep a close eye on the construction progress, which had experienced some delays previously.

Outlook for overseas operations. On the regional front, we believe that the worst is likely over for Resorts World Singapore’s operations as we expect its luck factor and bad debt provisions to normalise going forward. However, we caution that Genting’s Bimini operations are looking increasingly unlikely to achieve an EBITDA breakeven by end-2015. We now expect operational turnaround to happen in 1H16. We also expect its UK operations to face further headwinds due to dwindling VIP visitations resulting from China’s crackdown on corruption.

Disappointing 3Q15

3Q15 earnings of three out of the four gaming companies under our coverage fell below expectations. Notably, Genting Singapore (GENS SP, TRADING BUY, TP: SGD1.00) reported another weak quarter as 3Q15 bad debt provisions jumped over 60% QoQ to SGD92.5m. Genting Malaysia (GENM MK, NEUTRAL, TP: MYR4.18), meanwhile, suffered the same fate as earnings disappointed on subpar luck factor as well as rolling volume under its UK segment due to volatile business environment. By the same token, Genting’s (GENT MK, NEUTRAL, TP: MYR7.27) 3Q15 numbers came in below expectations as the weakness in its gaming segment was further exacerbated by a subpar showing from its plantation division, as productivity was affected by the recent drought. Magnum (MAG MK, NEUTRAL, TP: MYR2.61) was the only exception as the group reported a decent quarter with a third interim DPS of 2.5 sen being declared (9M15 DPS totalled 12.5 sen at an implied payout ratio of 94.7%). BJ Toto (BST MK, NEUTRAL, TP: MYR3.22), on the other hand, is scheduled to release its 2QFY16 (Apr) results on 18 Dec 2015.

Malaysia: GITP could boost visitation in the long run

On a positive note, Genting Highlands’ 3Q15 EBITDA margin registered a year-high of 37.0% due to its successful cost rationalisation. We attribute this to Genting Malaysia’s more stringent approach in operating cost control and we believe this could potentially be the new normal going forward (barring any one-off pre-opening expenses to be incurred to spur interest and create awareness on its GITP. Management guided that the MYR5bn capex allocated for its GITP remains unchanged as the group is tweaking some of its project budgeting to mitigate the impact from the persistent MYR weakness. Recall that GITP is implemented over two phases. Phase 1 includes: 1) the MYR300m 1,300-room hotel tower 2A (completed in 2Q15), 2) the MYR1bn 20th Century Fox World outdoor theme park (to be completed by early 2017), 3) the 450k sq ft Sky Avenue and Sky Plaza shopping malls (progressive openings beginning mid-2016), 4) 3,000 car park bays and a new cable car hub at the proposed Genting Premium Outlet site near Awana Resorts (to be ready by end-2016), 5) upgrading of sewerage, roads, water and power plants costing MYR1bn, and 6) the refurbishment of existing hotels costing MYR1bn (this could potentially involve the conversion of the existing Theme Park Hotel into a 20th Century Fox-themed hotel). Phase 2 of the GITP will involve construction of two new hotel towers known as Tower 3 and 4 (with 1,150 rooms each). This will cost an additional MYR1bn and we expect construction to begin by end-2017/early 2018.

While we continue to believe that GITP would help to boost visitation to the hilltop resorts over the long run (management targets 30m visitors by 2020 from 20m currently), we believe earnings accretion will only be meaningful come 2017 upon completion of most of the proposed facilities under its Phase 1 expansion. Our channel checks indicate that the new malls (Sky Avenue and Sky Plaza) could potentially house a new casino with an initial capacity of 50 new gaming tables, which will open its doors to visitors by end-2016. We deem this, coupled with the scheduled opening of the new outdoor theme park by early 2017, the most crucial elements in rejuvenating visitation interest. We will keep a close eye on the construction progress, which had experienced some delays previously.

Potential hike in gaming taxes?

On a side note, there have been speculations that the Malaysian Government could soon re-visit a potential hike in gaming taxes to help boost the nation’s tax coffers following the 42.9% hike in excise duties on local cigarttes in early November. We do not discount such a possibility as the Government is exploring various options to enlarge its taxation revenue base. The gaming industry contributes an estimated MYR2.5bn-2.7bn pa in gaming-related taxes and an additional MYR800m-950m in typical corporate taxes currently. We estimate that every 1% hike in casino tax could potentially erode Genting Malaysia’s earnings by 2.5-3% and Genting’s earnings by 1.5-2.2%. Meanwhile, the potential impact on the NFOs like Magnum and BJ Toto would be more profound with earnings erosion of 8-9% for every 1% hike in pool-betting duties. That said, we note that Malaysia’s existing tax rates (taking into consideration both gaming-related and corporate income tax rates) are amongst the highest in the region vis-à-vis Macau, Singapore and the Philippines.

Singapore: Worst is likely over

Recall that Genting Singapore reported a sharp spike in its bad debt provisions at SGD92.5m (+132.6% YoY, +63.5% QoQ) for 3Q15, resulting in earnings disappointment for the quarter. That said, we expect to see improvements in the quality of its books come 2016 owing to the group’s improved credit extension policy and collection procedures over the past 9-12 months. Luck factor aside, we expect a gradual recovery in both its VIP and mass market segments going forward, as we continue to believe that the worst is likely over for the group. On a side note, management indicated that most of its previously-outstanding positions have expired or been settled. Notably, its available-for-sale financial assets closed at SGD495.9m (-53.4% QoQ), while the derivative financial instruments under its current liabilities reduced to SGD54.5m (from SGD276.5m in 2Q15) as of end-Sep 2015. This, in our view, would help to address concerns over the volatile nature of its recognition of fair value losses/gains for its holdings of derivatives and financial instruments.

US: Bahamas showing signs of improvements

Moving over to the US, contribution from Resorts World New York remained largely stable in 3Q15 as machine wins held fairly stable at USD440 per day, while profitability was further enhanced by lower payroll expenses. We expect growth to normalise at mid-single digits going forward as we believe that patronage is hitting maturity since the resort first opened its doors in 2011. On its Bimini operations, although it looks increasingly unlikely that the unit could achieve an EBITDA breakeven by end-2015 (3Q15 EBITDA losses amounted to USD19m), we expect operational turnaround to happen in 1H16. This, in our view, would be driven by higher patronage to the islands following the full opening of Resorts World Bimini’s new 300-room luxury hotel.

UK: Volatility remains

We expect Genting Malaysia’s UK operations to face further headwinds over the near term as management acknowledges that its VIP segment could face further pressure due to China’s crackdown on corruption. Recall that the segment swung into EBITDA losses of MYR148.5m in 9M15 vs a MYR156.0m profit in 9M14. This was despite the 23% volume growth under its mass market operations, as its VIP business experienced an unprecedented 75% plunge in topline as the 13% decline in rolling volume was further exacerbated by subpar hold rates. On the other hand, the GBP150m Resorts World Birmingham recently commenced operations on 21 Oct 2015. We understand that retail outlets, restaurants, the 11-screen cinema, the 178-room Genting Hotel, and the Genting International Casino are progressively opening up to visitors. Based on our channel checks, the casino at Resorts World Birmingham will accommodate up to 30 gaming tables and 150 slot machines. While this pales in comparison to Resorts World New York’s 5,100 video lottery terminals, we believe this latest addition should further strengthen Genting Malaysia’s presence in the UK market, in which the group currently owns 40 small-scale casinos. Based on our estimates, this new facility could potentially add GBP50m-70m to Genting Malaysia’s topline and lift its EBITDA by 2.1-3.5% upon full commissioning of the facilities on a full-year basis. We have yet to factor this into our forecasts at this juncture.

South Korea: Work in progress

On Genting Singapore’s proposed USD2bn Resorts World Jeju (RWJ), soil works are currently nearing completion – with construction works on track to commence by early 2016. We expect the soft opening of the casino (subject to the official award of a gaming licence) to take place earliest by end-2017. Other proposed facilities such as the theme park, the waterpark, retail and food complexes, and hotels will likely commence operations progressively in 2018. Upon full completion by 2019, RWJ will accommodate the largest family theme park in Jeju island offering more than 20 rides and attractions in seven different themes while its premium hotels will house over 2,000 rooms and luxury villas, including the island’s first 6-star hotel. On the regulatory front, we gathered that Genting Singapore has submitted an application for a gaming licence for its RWJ. This comes after the South Korean government’s decision to invite applications for two gaming licences to build integrated resorts with casinos (at minimum investment of USD850m) that would only be open to foreign players. Competition, however, is likely to escalate as local media reports suggest that over 30 consortiums had submitted their applications.

Las Vegas: Budget being finalised

On the proposed Resorts World Las Vegas, management indicated that the development plan is still being finalised with its capital outlay to be determined by end-2015. Recall that the group has earlier on set aside USD4bn for the venture. However, we believe that the group could trim its budget allocation to USD2bn-3bn given the persistent softness in gaming interest from the Chinese market. Management reiterates its previous guidance that construction could start as soon as mid-2016 with the first phase of the integrated resort scheduled to open by mid-2018.

Miami: Slots licence up for grabs?

Moving over to the state of Florida, Governor Rick Scott has approved a new gaming compact with the Seminoles tribe in early December. The 20-year compact includes a guarantee that the tribe will generate USD3bn in added revenue to the state over the course of seven years. While official details are scanty at this juncture, local media reported that the deal could pave the way for the addition of slot parlors at existing pari-mutuel businesses in Palm Beach and Miami-Dade counties. We understand that should this gaming compact be approved by the Legislature by 1H16, Genting Malaysia might be able to apply for a licence for slot machines operations on its existing Biscayne Bay site, which is located in the Miami-Dade county. That said, feedback on the new agreement has thus far been mixed amongst existing local lawmakers given the political and social risks involved. Hence, we believe it is too early to turn positive on Genting Malaysia’s Miami venture for the time being.

Japan: A 2016 story at best

On a side note, local media in Japan reported that the ruling Liberal Democratic Party has decided against holding an extraordinary Diet session during the autumn. This, if materialises, will mark the first time in a decade that Japan’s two-chamber Diet has put off its fall session, which may spell further delays in pushing through the nation’s gaming bill.

NEUTRAL stance reaffirmed

All in, we maintain our NEUTRAL stance on the sector as we step into 2016 given the dearth of major re-rating catalysts over the near term. Within Malaysia, Genting Malaysia remains our Top Pick given its earnings defensiveness and as its MYR5bn capex for Genting Highlands could propel earnings growth in the long run. We also see trading opportunities for Genting Singapore, given its attractive current EV/EBITDA valuation at a steep discount of 41%/44% over its historical mean of 10.0x and Macau gaming peers’ 10.6x respectively. In the NFO segment, we continue to see Magnum and BJ Toto as appealing dividend plays as the duo offer decent annual dividend yields of more than 6%. Industry growth, however, is unlikely to be exciting in the foreseeable future – at an annual growth of low single digits – due to the continued proliferation of illegal operators. Key risks to our sector recommendation include: i) a potential hike in gaming taxes, ii) further reforms by the Chinese government to eradicate corruption (which could affect VIPs’ visitation), and iii) further construction delays in ongoing expansion plans, which could spark negative sentiment. We also caution that foreign shareholdings of Genting Malaysia and Genting are relatively high at approximately 39% and 47% respectively and hence could be susceptible to some selling pressure if foreign selldown on local equity market resurfaces

Source: RHB Research - 18 Dec 2015