Trade developments between the U.S. and China have influenced investor sentiment and global growth expectations across both equity and credit markets. The effect of these trade talks has been particularly visible in the gaming credits with exposure to Macau, the largest gaming market in the world, which receives most of its inbound visitation from mainland China. These credits have benefited from Chinese stimulus while facing the negative effects of comparatively slower Chinese economic activity. Additionally, these gaming companies are organized with a unique corporate structure that impacts the analysis of their credit metrics and credit support.
The net impact of geopolitical uncertainty, expansionary monetary and fiscal policy, and a slowing economic backdrop can be seen in the chart above. Gross gaming revenue, calculated as total dollars wagered less winning payouts, is an operating metric that investors use to gauge the health of gaming markets. The chart illustrates how the VIP segment of the Macau gaming market has come under pressure in recent months, while the mass market has outperformed.
Management teams at these companies have referred to the VIP segment as “choppy” and “rugged” on their earnings calls this year. They have pointed out that VIP customers, who primarily rely on air travel to enter the Macau market, have been impacted by protests in Hong Kong airports and are some of the first members of the economy to feel the effects of currency fluctuation. In 2018, visitors from Hong Kong accounted for 17% of the gaming traffic into Macau. However, many operators with a large VIP presence in Macau and its Cotai section have used this slowdown as an opportunity to renovate and reinvest in their higher-end offerings. The upgrades have increased capital expenditure and decreased annual free cash flow for these companies.
The mass market, which is further segmented into core and premium mass markets, has shown comparative year-over-year strength, albeit against an easy comparison due to Typhoon Mangkhut in 2018. The earnings and credit performance of companies in this space have followed suit. In preparation for the upcoming concession renewal in 2020, many casino operators in Macau have increased the capital expenditure they allocate to this aspect of the market.
Key Takeaway
In 2019, the VIP segment of the Macau gaming market has come under pressure while the mass market segment has strengthened. Going into Q3 earnings, investors in this space would be well-served to consider which operators have the capacity to benefit from these trends, while also considering corporate structure and capital allocation policies.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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