Time to Make a Bet
Timothy Fung, Head of Equity Advisory, Asia
Summary
Macau gaming has underperformed significantly due to a double whammy:
(1) the Delta variant hurting visitation/gross gaming revenue (GGR), and
(2) negative sentiment arising from regulatory risk as China pushes for “Common Prosperity”. However, some positives are starting to come through, marking a potential turnaround.
Fundamentally, pent-up demand remains intact, as can be seen in the recovery of US gaming revenues, China retail and the rise of the iGaming industry in the US, but the issue lies in travel restrictions.
August low base sets stage for strong rebound – Year-to-date (as of 26 August 2021), Macau stocks are down 20%-42%, making them one of the worst performers of the Hang Seng Index. August 2021’s visitation/GGR has been impacted negatively but this should set up a low base for a recovery in September 2021 as visitation picks up and GGR normalises to at least April/May 2021 levels.
Macau GGR/visitation has been running at less than 40%/30% of 2019 level. While we do not have full visibility on quick border reopening between HK-Macau-Mainland, we do expect eventual recovery in GGR/EBITDA to pre-COVID levels, providing more upside to stock prices over time.
Market expectation is very low – Macau currently trades on 10.8x FY2022e Enterprise Value (EV) /EBITDA, which represents a 22% discount to mid-cycle valuation. Despite possible near-term market overshoot, this undemanding valuation should provide great valuation support.
We continue to see value in the sector and believe that demand is intact and FY2022/23e EBITDA could recover back to 2019 level. We suggest investors who have a medium-to-long-term time horizon to gradually build positions in Macau gaming stocks.
We trimmed some positions in China Internet names in view of regulatory tightening, but increased exposure to hardware tech names which had received strong policy support. We also increased exposure to sportswear names on structural market share gains by the local Chinese brands.
Macau gaming – Improving visibility
The Macau gaming sector has underperformed significantly due to a double whammy of (1) renewed tightening control measures and travel restrictions implemented in July/August 2021 in China and Macau due to the Delta variant, hurting visitation/gross gaming revenue (GGR), and (2) negative sentiment arising from regulatory risk as China pushes for “Common Prosperity”. This is opposite to what investors are looking for as re-rating catalysts, namely border reopening, e-visa channel opening and announcements of potential extension of licenses. Macau’s Legislative Assembly also released a report [1], which highlights that Macau gaming matters to national security.
Macau gaming saw a broad-based rally towards end August on news that the local government has lifted the status of Immediate Pandemic Prevention and announced the easing of negative virus test validity for Guangdong to 7 days, effective 25 August 2021. This is a relaxation from the 48-hour validity rule introduced on 9 August 2021 and the measure covers both direct inbound and outbound land trips between Macau and Guangdong.
The easing came about after China achieved zero local cases for the first time since July 2021 after a month of draconian curbs, suggesting that the outbreak in mainland China appears to be under control. The vaccination rate in China has also picked up significantly and could probably reach more than 80% by the end of this year, according to the country's top pulmonologist Zhong Nanshan [2].
Pessimism seems priced in
Year-to-date, Macau stocks are still down 20%-42% (as of 26 August 2021), making them one of the worst performers of the Hang Seng Index. The good news is that after the sharp de-rating, positive catalysts could still come through if investors are patient. For now, August 2021’s visitation and GGR will be impacted negatively but this should set up a low base for a recovery in September 2021 as visitation picks up and GGR normalises to at least April/May 2021 levels with the easing of travel restrictions.
Read HK China Equity Perspectives August, 2021: Will Policy Risk Continue to Weigh on China Tech?
Pent-up demand remains intact
The bigger call is – have fundamentals bottomed out and will we return to pre-COVID levels? We believe pent-up demand remains intact, as can be seen in the recovery of US gaming revenues, China retail and the rise of the iGaming industry in the US, but the issue lies in travel restrictions. 2Q21 US land-based annualised revenue of US$54bn is already 21% higher than pre-COVID level in 2019, despite online gaming growing simultaneously. China’s retail sales in 2Q21 (annualised) at Rmb45 trillion is up 10% vs 2019 as well.
Macau GGR/visitation has been running at less than 40%/30% of 2019 level. While we do not have full visibility on quick border reopening between HK-Macau-Mainland, we do expect eventual recovery in GGR/EBITDA to pre-COVID levels, providing more upside to stock prices over time.
The eventual EBITDA recovery in 2023e could also be higher than 2019 level due to mass market growth, cost cutting, higher China GDP and no real substitutes, like what we saw in the last recovery in 2016/2018 after the anti-corruption campaign in 2014/2015.
Undemanding valuation with 22% discount to mid-cycle valuation
In terms of valuations, Macau trades at a historical long-term average EV/EBITDA of 12.8x and a mid-cycle EV/EBITDA of 14x. Since the COVID outbreak, the EBITDA estimates have collapsed, so there is no point looking at 12-month forward EBITDA, and we look at FY2022e, which is supposed to be a normalised year. The sector is trading at EV/EBITDA of 10.8x on consensus FY2022e EBITDA estimates, slightly below 1 standard deviation. This 22% discount to mid-cycle EV/EBITDA implies very low market expectations. Despite possible near-term market overshoot, this undemanding valuation should provide great valuation support.
We continue to see value in the sector and believe that demand is intact and FY2022/23e EBITDA could recover back to 2019 level. Yes, 2023 may be far, but if the market comes to the realisation that there is a clear path of recovery, we believe they could use that as a valuation benchmark (FY2023e EV/EBITDA 7.5x).
We suggest investors who have a medium-to-long-term time horizon to gradually build positions in Macau gaming stocks.
[1] Monitoring Committee for Land and Public Concession Affairs, The Legislative Assembly of Macau, 2 August 2021.
[2]“China likely to achieve herd immunity by year-end with 80% population vaccinated: top respiratory expert Zhong Nanshan”, Global Times, 20 August 2021.