Macau Analyst Who Called Stock Drop Says Worst Yet to Come

The worst is yet to come for Macau casinos after February gaming revenue plunged the most on record, according to one of the few analysts who correctly predicted the stocks would fall this year.

Gaming revenue will keep sliding through mid-year and dividends will be cut as the cost of new capacity eats into free-cash flow, leaving share valuations too expensive, said Jamie Zhou, an analyst at Macquarie Securities in Hong Kong. Zhou was one of just two analysts tracked by Bloomberg with sell ratings on Sands China Ltd. and Galaxy Entertainment Group Ltd. when he started covering the shares in December.

The two largest casino operators by market value in Macau have since tumbled at least 20 percent as China’s economic growth slowed to the weakest pace since 1990 and President Xi Jinping’s anti-graft campaign deterred VIP gamblers. While a gauge of Macau casinos rallied the most in two weeks on Tuesday as the revenue drop was smaller than some analysts predicted, Zhou is keeping his sell recommendation on the industry.

“Macau is in a tough spot,” Zhou said in an e-mailed response to questions from Bloomberg News. “We believe dividends will be slashed across the board.”

The six main casino operators -- Sands, Galaxy, Wynn Macau Ltd., SJM Holdings Ltd., MGM China Holdings Ltd. and Melco Crown Entertainment Ltd. -- lost $89 billion in market value over the past year, according to data compiled by Bloomberg. An index of the stocks fell 2.5 percent on Wednesday, bringing its 12-month slump to 47 percent.

Revenue Drops

Gross gaming revenue in the world’s biggest gambling hub fell 49 percent to 19.5 billion patacas ($2.4 billion) last month, Macau’s Gaming Inspection and Coordination Bureau said. That compared with expectations of a 54 percent decline, according to the median of eight estimates compiled by Bloomberg News.

Macau, a former Portuguese colony, last year posted its first annual decline in gaming revenue. The industry may face another 8 percent drop this year, a Bloomberg survey showed, after last year’s 2.6 percent fall. SJM Holdings dropped 3.7 percent in Hong Kong to lead declines among casino stocks on Wednesday. Wynn Macau declined 2.8 percent, MGM China sank 2.6 percent, Galaxy fell 2.9 percent and Sands China lost 1.7 percent. Melco Crown added 0.8 percent.

Most analysts have remained bullish, with Zhou’s sell ratings putting him at odds with peers. The average consensus on the six operators is 3.8 on a scale where 5 equates to a unanimous buy recommendation. That’s in line with the score for the members of the Hang Seng Index, data compiled by Bloomberg show. Strategists are most bearish on Wynn Macau, with eight sell calls out of 28 recommendations. Zhou is now the only analyst advising investors to offload Galaxy shares.

Lower Dividends

Analysts are too optimistic about the outlook for shareholder payouts by casinos, he said. As well as the revenue decline, wage inflation will boost expenses and the cost of opening new venues will drain cash, said Zhou.

“We don’t think the street has fully grasped the negative operating leverage in their earnings forecasts,” said Zhou, referring to other analysts. “While consensus have 5-7 percent forward dividend yields, we see only 2-4 percent at best.”

Macau casino operators were some of Hong Kong’s best stocks to own in the five years through 2013, with Galaxy rallying more than 6,400 percent, as more than eightfold growth in gaming spending over the decade through 2013 transformed the former Portuguese enclave into a gambling center larger than the Las Vegas Strip.

Finding Bottom

President Xi in December urged Macau to wean itself off its reliance on casinos and turn the city into a tourism and leisure center. His campaign against corruption has snared more than 100,000 “flies and tigers,” or low- and high-level officials, according to official data.

“Macau gaming will take some time to recover. They’re still struggling to find the bottom,” said Sandy Mehta, the Hong Kong-based chief executive officer of Value Investment Principals Ltd. “The crackdown on conspicuous consumption is the biggest headwind. It is great that the Chinese leadership is improving transparency and governance, but Macau will continue to feel the brunt of these measures.”

Representatives for Sands China and Galaxy declined to comment on the companies’ dividend plans. The four other casino operators didn’t immediately respond to requests for comment from Bloomberg News made after regular office hours on Tuesday.

The slump in gaming stocks has made shares cheaper. The BI Macau China Gaming Market Competitive Peers Index traded yesterday at 16 times earnings, compared with its five-year average multiple of 20.3. Casinos slid last month to the lowest valuation relative to the Hang Seng Index since the middle of 2012.

No Bargain

For Macquarie’s Zhou, they’re still not a bargain. He has a 12-month target price of HK$31 on Sands, 14 percent below Tuesday’s close. He sees a 15 percent decline to HK$18 for Wynn Macau, and a 17 percent drop to HK$33.20 for Galaxy Entertainment.

The addition of more hotel rooms in Macau and capital spending commitments mean “industry level free cash flow will be negative for years to come,” he said. Shares remain expensive, “particularly with further downside possible.”

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