• Still NEUTRAL on number forecast operators (NFOs). We believe the NFO stocks under our coverage should have high defensiveness, thanks to their dividend yields (5-7%) and the relatively inelastic demand from punters. That said, we think the current market valuations (close to mean levels) are fair, and the sector lacks re-rating catalysts for their earnings and valuations to reach new highs. We prefer Sports Toto (SPTOTO) on valuation grounds and its superior dividend yield.

• 4Q23 results below expectations. SPTOTO's earnings fell short of expectations due to a higher-than-average prize payout resulting from a sizeable jackpot payout (Figure 5) during the quarter, coupled with higherthan-expected operating costs from HR Owen. That said, its DPS of 2 sen (YTD: 5sen) was within expectations. Meanwhile, Magnum’s earnings and dividends exceeded our projections, due to our previous conservative forecasts. We upgraded the stock to NEUTRAL from Sell, as we see limited downside to valuations after lifting our forecasts.

• Outlook. We believe that lottery ticket sales in 1Q24 could swing north due to positive seasonal factors, particularly driven by the Lunar New Year period. Beyond the immediate term, the NFOs’ management teams noted that illegal NFOs are gaining significant market share in two northern states, which are underserved, following the closure of legal NFO outlets. The path to sales recovery may not be straightforward due to the strong market share of illegal NFOs. However, we believe stricter legislation and enforcement, as well as the legalisation of online gaming could be key catalysts for the sector. However, it appears that such policies are not presently the Government's top priority.

• Service tax hike. The Government's decision to raise the service tax rate by 2ppts, from 6% to 8% starting Mar 2024, will impact the profitability of NFOs. NFOs have been absorbing similar taxes since the introduction of the Goods and Services Tax or GST in 2015, and the subsequent re-implementation of the Sales and Services Tax or SST in 2018. This additional increase further burdens them with taxes. Meanwhile, reducing prize payouts or increasing ticket prices could lead to decreased sales and a loss of market share to illegal NFOs. Therefore, NFOs must absorb these additional costs without adjusting ticket prices or diminishing prize payouts. We have taken into account the higher tax rates in generating our forecasts.

• SPTOTO’s HR Owen will continue to face challenges from high inflation and interest rates in the UK. With higher depreciation and interest expenses from its newly launched Hatfield showroom, we believe HR Owen's GPM will remain under pressure. That said, we highlight that SPTOTO’s dividends are mainly from its lottery business – so the challenges at HR Owen should not hamper the former’s dividend payouts.

• Key downside risks include unfavourable luck factor and policies, as well as softer-than-expected ticket sales. The converse represents the upside risks.

Source: RHB Securities Research - 6 Mar 2024