• 1Q24 sector results beat expectations on higher-than-expected sales during strong seasonality. Despite the lack of catalysts and the sector’s generally unexciting outlook, we believe the number forecast operators (NFOs) offer defensive qualities due to the inelastic demand from punters and their attractive yield profile. We prefer Sports Toto (SPTOTO) on valuation grounds and superior yield. Maintain NEUTRAL.

• 1Q24 results roundup. SPTOTO’s earnings and dividend exceeded expectations, primarily due to higher-than-expected sales in the gaming and motor segments, driven by stronger seasonality. Gaming ticket sales rose due to the Lunar New Year festive season, while motor revenue was boosted by the release of new vehicle registration plates in the UK. On the other hand, Magnum's (MAG MK, NEUTRAL, TP: MYR1.08) results disappointed, due to an unfavourable luck factor (prize payout: 1Q24: 67.6% vs 1Q23: 64.6%).

• Approaching a softer season. Lottery ticket sales for the following quarter are expected to decline after the recent strong sales driven by the Lunar New Year period. Beyond the immediate term, NFOs recognise the ongoing threat posed by illegal NFOs and believe the latter has gained market share, especially in the two northern states where the state governments do not allow NFO outlets to operate. This not only hampers sales recovery but also results in significant tax revenue losses for the Federal Government. In response to the ban on outlets, we understand that the NFO players are still in talks with the federal and state governments in search of remedies (eg relocation) to the current situation. Key catalysts for sector re-rating include the enactment of stricter legislation against illegal NFOs and the legalisation of online gaming. However, we believe the favorable policies for NFOs are currently not prioritised by the Federal Government.

• SPTOTO’s HR Owen sales are also expected to decline after a seasonally strong 3QFY24 (Jun). We believe it 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 margin will remain under pressure. That said, we highlight that SPTOTO dividends are mainly from its lottery business. Hence, the challenges at HR Owen should not hamper SPTOTO’s dividend payouts.

• Forecast and ratings. Post results, we lifted SPTOTO’s FY24F-26F earnings by 14-9% after incorporating a stronger sales assumption. On the other hand, we cut Magnum’s FY24F earnings by 5.4% to account for the high 1Q prize payout, but maintained FY25F-26F earnings, as the luck factor/prize payout ratio typically reverts to the mean over time. We reiterate our sector NEUTRAL call – while ticket sales are gradually improving and inching closer to pre-pandemic levels, we believe the current sector valuation – close to its mean – is fair and that the market has already priced in the recovery in ticket sales.

• 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 - 21 Jun 2024