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Macau Gaming Sector Macau Consumer Discretionary 24 October 2016 Macau Gaming Sector Tug of war between the bulls and the bears We are mindful of overall euphoria and upcoming data points which may be taken as positive by the market, starting with the 3Q16 results But we remain cautious overall on sector fundamentals and highlight Jamie Soo the clear mismatch between expectations and reality (852) 2773 8529 Although we revise up our TPs across the board and expect share [email protected] prices to be range-bound near term, we retain our Negative sector call Adrian Chan, CFA (852) 2848 4427 [email protected] What's new: There continue to be mixed signals and conflicting Key stock calls commentaries in the market, which have resulted in a high degree of New Prev. uncertainty among investors and increasingly volatile share prices. This Wynn Macau (1128 HK) Rating Sell Sell report is our attempt to analyse, objectively, the underlying realities and Target 9.70 9.50 fundamental developments. Downside q 17.5% Galaxy Entertainment Group (27 HK) What's the impact: The good. We expect the 3Q16 results to be the best Rating Outperform Hold quarterly results since 1Q15 (Daiwa: 8% YoY/10% QoQ adjusted EBITDA Target 31.80 27.40 Upside p 5.8% growth). Sands and Wynn are likely to be the outperformers, with adjusted EBITDA rising cumulatively by 11% YoY/16% QoQ, on our forecasts. On the Source: Daiwa forecasts policy front, we believe we have found the “policy bottom” in Macau and the government will tighten policies in a gradual but continuous manner going forward. And the revenue mix is improving, with 3Q16 seemingly set to bring one of the most favourable mass revenue mixes in Macau’s history. We believe GGR is close to bottoming and benefiting Cotai-ready operators, and we still forecast mass revenue to rise by 8% YoY for both 2017/18E. The bad. On the flip side, we question the sustainability of the earnings recovery. We expect the 3Q16 outperformance to have been largely driven by: 1) record-high pre-opening expenses incurred but excluded from adjusted EBITDA, 2) favourable hold, and 3) a short-term lift in VIP liquidity. Other fundamental concerns include: 1) the recent high-profile departures of casino senior management, 2) a sustained structural decline in patron quality, 3) the ongoing price war and its risks to margins, and 4) misplaced hopes for cash-flow growth and the sustainability of dividends. Indeed, the market’s earnings expectations for 2017/18 still look far too optimistic to us, at 15%/18% above our forecasts (for core EBITDA). Earnings revisions. We are adjusting our cost assumptions by cutting our new tables for upcoming openings by 40% (from 250 to 150). This sees our sector adjusted EBITDA rise by 3% in 2016/17E. We lift our TPs by 13% on average as we roll over to 12-month forward EBITDA (from 2016E). We upgrade Galaxy (27 HK, HKD30.05) to Outperform (2) from Hold (3), and Sands (1928 HK, HKD34.45) to Hold (3) from Sell (5). Our top pick is Galaxy, and Wynn (1128 HK, HKD11.76) remains our key Sell (5). Our SOTP valuation methodology and sector GGR growth forecasts are unchanged. What we recommend: On a fundamental level, we still find it hard to justify current share prices and sector valuations. But, in the short term, looming data and overall market euphoria may work against our longer-term view. How we differ: Our 2016-18 GGR growth forecasts are below consensus, which still looks to be pricing in a “build it and they will come” scenario. See important disclosures, including any required research certifications, beginning on page 43 Macau Gaming Sector: 24 October 2016 Sector stocks: key indicators EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg Galaxy Entertainment Group 27 HK 30.05 Outperform Hold 31.80 27.40 16.1% 1.157 1.182 (2.1%) 1.215 1.216 (0.1%) Melco Crown Entertainment MPEL US 16.57 Hold Hold 15.80 14.50 9.0% 0.403 0.542 (25.6%) 0.423 0.928 (54.4%) MGM China Holdings 2282 HK 13.00 Underperform Underperform 11.30 9.81 15.2% 0.653 0.536 21.9% 0.468 0.131 258.7% Sands China 1928 HK 34.45 Hold Sell 32.80 26.30 24.7% 0.146 0.133 9.6% 0.144 0.132 8.5% SJM Holdings 880 HK 5.51 Hold Hold 5.60 5.10 9.8% 0.363 0.312 16.4% 0.208 0.218 (4.5%) Wynn Macau 1128 HK 11.76 Sell Sell 9.70 9.50 2.1% 0.323 0.131 146.7% 0.402 0.053 661.5% Source: Bloomberg, Daiwa forecasts Macau Gaming: 3Q16 adjusted EBITDA forecasts by operator In 3Q16E, we look for (in HKDm) 1Q16A 2Q16A 3Q16E QoQ YoY sector adjusted EBITDA MGM 995 1,034 1,085 +5% -2% SJM 838 796 825 +4% -7% to rise 8% YoY and 10% Sands 4,011 3,783 4,500 +19% +6% QoQ, representing the Galaxy 2,433 2,273 2,400 +6% +14% best quarter since 1Q15 Wynn 1,486 1,481 1,630 +10% +29% Melco 1,928 1,901 1,950 +3% +6% Sector 11,692 11,268 12,390 +10% +8% Source: Companies, Daiwa Macau Gaming: sector pre-opening expenses by quarter But the sustainability of (HKDm) an earnings recovery is 1,000 in question: 3Q16E’s 800 outperformance is likely to be buoyed by the 600 single-highest quarter of 400 pre-opening expenses, 200 which are excluded from the calculation of 0 “Adjusted EBITDA” 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16E Total Sands and Wynn Source: Daiwa estimates, Companies Macau Gaming: mass market revenue growth (Street vs. Daiwa) We expect mass revenue Daiwa(1) Consensus growth to pick up 2014A 2015A 1Q16A 2Q16A 3Q16E 4Q16E 2016E 2017E 2018E 2016E 2017E 2018E Mass GGR (MOPm) 121,458 98,599 24,995 24,334 25,916 25,325 100,571 108,617 117,306 106,487 120,331 134,770 substantially in 2017E, ∆ YoY 16% -19% -1% 2% 5% 2% 2% 8% 8% 8% 13% 12% but market expectations strike us as being unrealistically high Source: Companies, Bloomberg, Daiwa forecasts Note: (1) our mass revenue growth expectations are unchanged in this report 2 Macau Gaming Sector: 24 October 2016 Table of contents An objective look at the mixed signals ahead ....................................................... 4 1. Top line: gross gaming revenue ................................................................................... 4 2. Earnings: on adjusted EBITDA .................................................................................... 9 3. Other near-term catalysts .......................................................................................... 14 4. Macau’s free cash flow and dividend sustainability.................................................... 15 5. Sector valuations ....................................................................................................... 18 Financials ................................................................................................................ 20 Earnings revisions ............................................................................................................. 20 Our stock preferences ....................................................................................................... 21 Risks ........................................................................................................................ 23 3 Macau Gaming Sector: 24 October 2016 An objective look at the mixed signals ahead 1. Top line: gross gaming revenue Growth in 3Q16 In 3Q16, mass GGR Average daily GGR posted +1% YoY /+5% QoQ growth for 3Q16, marking the biggest reached levels not seen incremental growth over the past 9 quarters (on both a YoY and QoQ basis). Anecdotally, since 1Q15 this quarter witnessed an overall favourable hold environment which helped lift the overall revenue base for the quarter. On our numbers, mass gaming revenue also improved by 6- 7% QoQ. We expect 3Q16 earnings (at the adjusted EBITDA level) to reach their highest level since 1Q15 (see page 9 for an in-depth discussion), partially as a result of this mass gaming revenue growth. Gaming revenue mix change still favourable for casino operators Mass revenue in 3Q16 reached the highest level since 4Q14 Macau has experienced this GGR growth despite a number of well-documented junket closures across Macau. While these closures should have resulted in a consequent weakness in the overall VIP segment, VIP gaming revenue was lifted by the well- documented short-term surge in VIP liquidity post-Wynn Palace’s opening in August 2016. That said, on a net basis over the course of the quarter, we expect the improvement in GGR to have been sustained and benefit the casino operators’ revenue mix. As a matter of fact, 3Q16 is likely to have been as favourable for VIP/mass revenue mix as in 2Q16 (which saw the most favourable mix in Macau’s history). GGR ADR run rate trend (by quarter) GGR mix (by quarter) (MOPm) 100% 1,200 1,102 90% 970 80% 1,000 874 70% 798 60% 800 699 50% 607 602 597 574 579 551 600 40% 30% 60% 59% 52% 52% 56% 400 44% 45% 48% 20% 36% 40% 39% 10% 200 0% 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 0 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 Mass+slots VIP Source: DICJ Source: Daiwa, Companies Cotai properties are gaining market share, as expected Cotai’s inflection point is in order As we have noted before (see Cotai approaches inflection point, 17 September 2015), we continue to believe Cotai-ready operators are best-positioned fundamentally to capture the shift in market share from the Peninsula to Cotai (ie, Galaxy, Melco Crown, Sands China). While the shift is expected to be catalysed by the opening of the Taipa Ferry Terminal (TFT, now delayed to 1H17), we are already seeing tangible of this shift. Naturally, operators with a larger operational presence in Cotai stand to benefit at the expense of those with larger Peninsula exposure.
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