Donaco Offers Upside As New Casino Readies For Opening

This story features DONACO INTERNATIONAL LIMITED. For more info SHARE ANALYSIS: DNA

-Capacity enlarged greatly
-Tapping Chinese tourist growth
-Strong growth in returns envisaged
 

By Eva Brocklehurst

Donaco ((DNA)) is opening a new 5-star hotel and casino in the north of Vietnam. Brokers are excited. CLSA is initiating coverage of the stock with a Buy rating. The broker thinks this casino, scheduled to open in May, will be better exposed to gambling popularity across the border in China, tapping a market that the company was previously unable to service properly, given capacity constraints at existing operations.

CLSA's base case forecasts are for FY16 earnings of $80m, valuing the company at 7.7 times that amount, or $1.69 a share, a 30% discount to regional peers to reflect execution and regulatory risks. This base case assumes both VIP and mass market table yields decline sharply once the new casino opens, in response to a five-fold increase in tables. Despite this, the broker's analysis suggests yields will recover quickly, bottoming in FY15 and largely recovering by the end of the second half of 2016. CLSA acknowledges the valuation is effectively reflecting a casino that is not yet open, albeit with some indications from the existing, substantially smaller, casino.

The existing Lao Cai complex has been operating since 2003, with 34 rooms at 3-star, eight gaming tables and 36 machines. The new complex will boast 428 rooms at 5-star standard and have floor space to accommodate at least 50 tables and up to 300 machines. The opening was delayed to May, originally set for March, because of administrative hiccups. The existing casino has been forced to rotate VIP junkets, with its rooms completely booked out so the broker believes the new property should attract materially higher spending from Chinese residents. There is limited competition because Macau is inaccessible to many Chinese. The Lao Cai casino is readily accessible to a large potential customer base across the border in China, where casinos are banned. For the 46m residents of Yunnan province, and a number of other provinces, the Lao Cai casino is their closest legal gambling destination.

Infrastructure developments on both sides of the border, attractive VIP commission rates and the impending boom in Chinese tourism all add potential. In FY13 80% of revenue at the existing casino came from lower-margin VIP plays but still compared favourably to other casinos, thanks to low taxes and labour costs. The broker expects margins to approach 30% at the new property, benefitting from economies of scale and leverage. Of course, there's regulatory risks that go with the gaming territory but CLSA believes the returns outweigh these. The broker notes strong demand for gaming is evident in the region, not only from Chinese residents but also Singapore, Korea, Australia and the Philippines. CLSA is forecasting a 13% compound average growth rate across these markets over the next two years. Moreover, the supply/demand balance, or imbalance, is highlighted by the rate at which yields recover after new volume is added to the system.

Comparing forecasts to regional peers table yields in FY13 and based on FY16 forecasts, Lao Cai ranks well below Macau but ahead of Cambodia and the Philippines. CLSA thinks FY16 will be the best year against which to value the company, given FY15 will involve the ramp up of operations and fine tuning of marketing directed at China. BA-Merrill Lynch notes significant growth in the company's net table revenue in the first half. The broker believes the stock was always going to be an investment case from FY15 onwards and is confident in the growth potential. A price objective of $1.57 could prove to be conservative and Merrills retains a Buy rating.

Reflecting the conservative expectations, Merrills' forecasts assume $44,000 in net table revenue in FY15, versus the current $55,000, to reflect the increased numbers of tables. Scaling up table numbers from the initial 40 expected in July, to 50, provides upside revenue opportunity. Any liberalising of government controls on Vietnamese attendance will also add value upside. Vietnam current forbids locals to play at the casino but there are potential changes in the wings on that front and Merrills thinks, on a 3-year view, that could be an additional driver of growth. Merrills concurs that it's the focus on Chinese outbound tourism which is the key attraction. The positives for the broker are the robust VIP and slot machine turnover. Revenue from gaming machines grew 60% in the first half, with the new machines seeming to trade at relatively higher returns.

What else is on the company's strategic outlook? Donaco intends to spin out the mobile technology business, iSentric, by April. This is is a welcome move for Merrills, as the broker thinks the division lacks a connection with the main casino offering. The divestment will occur by way of sale to an ASX-listed company, leading to a planned in-specie distribution to shareholders. The $12m valuation of iSentric holds up well, in the broker's view, comparing with the acquisition price of $8.5m in June 2013.
 

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