Trade war creates headwinds for Macau gaming stocks

Macau gaming stocks are feeling the heat from the trade war between the U.S. and China, falling to their lowest levels in a year, with some analysts cutting their growth forecasts on concern for a slowdown in China’s economy.

Both Deutsche Bank and Morgan Stanley have both recently reduced their estimates for gross gambling revenue for this year and next. Deutsche Bank’s forecast for 2018 has been trimmed to 13.9 percent from 14.2 percent, while it expects growth to drop to 6.8 percent in 2019 and slow further to 5.1 percent in 2020.

Morgan Stanley, while noting that it still sees Macau as a long-term growth story, cut its 2018 GGR estimate to 13 percent from 16 percent and more than halved its estimate for next year to 5 percent from 12 percent previously.

“3Q18 EBITDA in general will disappoint, and we expect consensus earnings revision to be down meaningfully over the next few months,” Morgan Stanley analysts Praveen Choudhary, Jeremy An and Thomas Allen said in a report. “Macau in a slowing growth environment tends to underperform, and we do not expect the stocks to trade above long-term averages.”

According to International Monetary Fund forecasts, Macau’s economy will slow sharply this year to gross domestic product growth of 6.3 percent from 9.1 percent in 2017 and will be flat in 2019.

September GGR rose only 2.8 percent year-on-year – affected by casino closures during Typhoon Mangkhut and related disruptions. However, without the disruptions, analysts say growth would have still been in double digits.

And Union Gaming Managing Director and Head of Asia Research, Grant Govertsen, said that although stocks have fallen, as yet there is no discernible impact on the ground.

“Clearly everyone is on edge and watching to see what happens. There has been no change in customer behavior so far,” he said. “Obviously the stocks are baking in a significant downturn in Macau next year, which could, of course, happen although so far there are no obvious similarities so far between the global financial crisis-led slowdown in 2008/09 or the anti corruption-led slowdown in 2014/15 and today.”

Still, the trade war shows no sign of abating, with tariffs affecting about $260 billion in bilateral trade, which are already having a negative impact on China’s economy.

Factory activity stalled in September after 15 months of expansion, with export orders falling the fastest in over two years, a Caixin survey found. New investment growth is also at a record low.

On October 7th, Beijing announced it was cutting reserve requirement ratios by one percentage point from Oct. 15th to lower financing costs and give its economy a boost.

The trouble is many of the worst-hit provinces are the southern export-trade driven coastal regions, which form the main feeder markets for Macau.

“If you look at the Macau market, 75 percent of revenue is from VIPs and premium mass, these are basically high-net-worth individuals, with a lot from Guangdong and other coastal provinces,” Bernstein Research analyst Vitaly Umansky said in a recent podcast. “If their own economic situation worsens as a result of a trade war and China slows, we are going to have significant headwinds to new growth in Macau and that’s where the short-to-medium-term concern lies.”

Umansky said he is not optimistic of a short-term solution to the trade battle, which he sees as being part of a larger geopolitical struggle.

“If you take a step back and think about the parties around President Trump and their view of China as a strategic competitor, it’s hard to see how this all goes away relatively quickly.”

He said any trade concessions designed to trim the deficit are unlikely to be seen as a victory by those who regard China as a potential threat.

There is little doubt that the first sector to feel the strain will be the high rollers and those operators with the biggest exposure to VIPs will be the hardest hit.

Morgan Stanley recently raised its rating on Sands China, the most mass market-focused of Macau’s operators, to overweight from equal weight, while cutting Galaxy Entertainment from overweight to equal weight.

It cited Sands’ mass exposure, high dividend payout and yield and strong Q3 outlook for its decision. It also said it favours MGM China over Wynn Resorts and Galaxy as it’s cheap with the ramp up of its new Cotai resort not yet priced into the stock. It noted Wynn and Galaxy have high exposure to the VIP and premium mass business.

Longer term, there remains a question mark over whether the tension between Beijing and Washington will have any impact on the concession renewals for the Macau operating licenses.

Govertsen said it’s highly unlikely that trade wars will have any impact whatsoever “as we do not expect any decisions to be made until well after 2022.”

Umansky agreed that a present, the renewals are too far away, but added it’s something to keep an eye on. If tensions continue to ratchet up, the U.S. operators could find themselves at higher risk than the locals.