Australia | Nov 04 2013
-Macau holds the growth key
-Aust casino revenue slows
-MPEL dividend potential excites
By Eva Brocklehurst
Casino operator Crown ((CWN)) is increasingly depending on the Macau gambling connections to make the case for growth. The AGM update confirmed domestic trading is flat. What has piqued interest is that the AGM commentary also alluded to remarks from MPEL – the Macau gaming joint venture in which Crown has a one third stake – that a review of distribution policy is nigh.
BA-Merrill Lynch is confident Crown's broad portfolio and ability to control operating expenditure will stand it in good stead and offshore growth will insulate against the domestic headwinds. The AGM commentary has also confirmed MPEL public commentary that a dividend policy revision could occur in 2014. Merrills' model now assumes an arbitrary 20% pay-out from MPEL. Back home, main floor gaming (MFG) is struggling and it's clear consumer spending remains pressured, with rising petrol and utility bills cramping disposable income. There was some disruption from the Melbourne casino's refurbishment but the macro headwinds are considered more critical.
Revenue for the Australian casinos has definitely slowed. For the first 17 weeks of the first half, main gaming floor revenue was flat and non-gaming up 10%. This is below Citi's forecast for main gaming floor growth of 4% but slightly ahead of the non-gaming estimate of 8% in for the first half.
VIP seems to be volatile too, as, while there were better activity levels compared with the second half of FY13, overall it appears to be down on the prior corresponding period. The main driver of the Macau growth story to date has been high rollers but recently growth in the mass market segment outstripped the VIP market. With improving infrastructure, such as rail, CIMB expects this growth will continue and forecasts 31% growth in the mass market in 2013, 30% in 2014 and 32% in 2015. This shift in growth towards the mass market will also be beneficial to the group's margin. Non-gaming trading is also better than Merrills had thought. This is partly from new product but also could be reflecting stronger confidence. The revenue shortfall in MFG seems to the broker to have been largely replaced by non-gaming's relative outperformance, although this is lower margin business.
CIMB expects Sydney's VIP market will continue to grow strongly and that Crown will take a 50% market share once the new site opens. This broker also considers there is a strong likelihood that MPEL will pay a dividend in FY15. The Macau market continues to post strong growth rates and MPEL is winning market share across the main three product segments (mass market, VIP and slots). While there is some earnings risk associated with a slowdown in Perth, given the potential for a MPEL dividend in the short term and the benefits of Crown Sydney coming through in the medium term, CIMB thinks the bias lies to the upside.
Once MPEL initiates a dividend CIMB suspects it will start at a low level and progressively increase. Moreover, the broker suspects MPEL will want to maintain a consistent dividend policy and avoid the volatile patterns of its Macau peers, given the shareholder register. The dividends are expected to be at the low end of the historical pay-out ratio range in Macau and, therefore, 50% of net income which, based on CIMB's forecasts, would be US$414m in 2014 and US$497m in 2015. This would lead to a dividend pay-out to Crown of $143m in FY15. How much is this worth to Crown's valuation? Conservatively, CIMB expects MPEL will continue to grow at 20% over the next three years, with a long-term assumption of 10-15%. The broker also expects the pay-out ratio to rise to 60% in FY18 and 70% in FY20. Should these forecasts prove correct, all else being equal, it would add about $4.00 per share to the valuation.
Despite the softness in local business, Citi is not inclined to change earnings forecasts until MPEL's third quarter result is published on November 5. Crown's new developments are still at the "potential" stage. Sydney remains in Stage 3 of the unsolicited proposals process, discussions on the Sri Lankan casino continue and Crown is waiting for further information from the Queensland government on a new Brisbane casino. While Brisbane is a new focal point, Citi questions whether Crown has the flexibility to undertake all three projects. Estimates show net debt to earnings would exceed 2.5 times during peak capex needed in FY16-17, if all three went ahead. Hence, the MPEL investment would account for over 40% of earnings and should be Crown's principal earnings driver in FY14.
MPEL's City of Dreams is benefitting from its position as a mass-market destination, which is underpinning margin growth. New openings in the Philippines in mid 2014 and Macau's Studio City in mid 2015 should also ensure the strong earnings momentum will continue over the next 2-3 years. All that said, Citi is inclined to stay in Neutral on Crown and thinks the strong run in the share price reflects the improving fundamentals for MPEL but ignores the softness in the domestic properties.
Crown has increased its Buy ratings on the FNArena database since the stock was covered at the FY13 results. There's now seven instead of five. The contrary one is Citi, with a Neutral rating. The consensus price target of $18.09 signals 6.2% upside to the last share price and compares with $17.06 ahead of the AGM.
See also, Stakes Raised In Australian Gambling Market on September 17 2013.
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