Macau gaming:Warning,margin and yield may be
Event
Despite a 40-50% pullback in the share price over the last 12 months, Macaustocks remain expensive trading at 13x average FY16E EV/EBITDA vs. theirfair cycle average of 12x and 2012 bear cycle average of 10.6x, despite muchweaker fundamentals as compared with two years ago. The sector’s keyvaluation support seems to be the 4.3% and 4.5% consensus FY15E and 16Edividend yields vs our forecasts of 2.4% and 2.1%.
Consensus is insufficiently factoring in negative operating leverage from atriple-whammy of declining GGR, while wage inflation and major capacityadditions will lift industry’s cash operating costs by 57% from FY14 to FY17during which time total GGR will largely remain flat (VIP -28%, Mass +39%).We detail in this note our cost structure analysis which leads us to believenegative FCF will force operators to cut dividends. Our updated GGR StressTest also shows material downside risk to yields on further weakening GGR.
Impact
Our EBITDA margins forecasts are 70-230 bps lower than Consensus:our key differentiation from Consensus lies in the way we model cashoperating costs. We divide each operator’s cost into four components: gamingtax, junket commission, labour cost and other cash costs. Labour cost, whileonly accounting for mid-to-high single digit of GGR, represents ~50% ofMacau operators’ total cash costs. We estimate at least 1% GGR growth or2.6% mass GGR growth is needed to offset cost inflation and maintain currentprofitability even in the absence of new capacity addition.
Resulting impact on FCF and dividend will be amplified by $14bn capex:adding on top of the negative operating leverage pressuring margins lower isthe US$14bn capex the industry will be deploying through 2017. While mostoperators remain in healthy balance sheet conditions currently, weakeningFCF will mean previous dividend payout policies will not be sustainableheading into peak capex years. Our aggregate FCF yields are -2.4% and2.1% for FY15 and FY16 respectively, vs consensus forecasts of -0.2% and2.8% respectively. Operators with the longest-tailed capex commitments(Galaxy, SJM) or large capex outlays relative to existing operation (MGM,Wynn) will need to prudently reduce or eliminate dividend payout.
‘Stress Test’ reveals still material downside risks: We refreshed ourStress Test on three different GGR scenarios. Even in a rosy Bull Scenariowhere GGR growth rebounds to double digit with ~25% mass GGR growth,EBITDA margin are likely to fall FY15/16E until rebounding by FY17. In a BearScenario, only Sands China will maintain stability in FCF yield.。
Outlook
We remain cautious on Macau due to rich valuations, further potentialearnings and yield downsides, and policy risks. We will get more constructiveon the sector if the following three events occur: 1) GGR recovers sequentiallyinto this year’s new opening, 2) capex restraints from operators, and 3) clarityon gaming concession renewal from the government.