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Morningstar | Raising SJM’s FVE to HKD 8.9 Per Share; SJM is Fairly Valued. See Updated Analyst Note from 01 May 2019

Narrow-moat SJM’s first-quarter adjusted EBITDA accounted for 31% of our full-year estimates, beating our estimates, while revenue is tracking towards our full-year estimate. The beat was helped by a HKD 57 million addition to adjusted EBITDA resulting from changes in accounting that now places lease expenses below the adjusted EBITDA line. We expect the same addition to adjusted EBITDA in the next quarter. Adjusted for the accounting change this quarter and the HKD 109 million one-off provision against a receivable from a gaming promoter at Casino Eastern in the fourth quarter, adjusted EBITDA would still have grown 7% sequentially, which is solid and still beat our estimate. The boost came from mix shift to higher-margin mass, a normalized mass hold rate in the premium mass segment compared with an abnormally low hold rate in the previous quarter, lower reinvestment costs associated with mix shift to grind mass, and cost-saving measures such as HKD 30 million savings from no-pay leave.

Our fair value estimate has been raised to HKD 8.9 per share from HKD 7.7 per share and we think SJM is now fairly valued. We have adjusted EBITDA margin upward to 0.7% to 0.8% in the coming years after factoring in mix shift to higher-margin grind mass businesses for Grand Lisboa and other self-operated casinos in the long term. We expect Grand Lisboa Palace to be the main venue for the premium mass customers of SJM. The recent fiscal and monetary stimulus by the central government should help the economy recover faster, providing a stronger gaming environment for Grand Lisboa Palace to ramp up. We lift our revenue growth estimates in 2020 and 2021 by 1%. Given the relatively weak execution in the past, we forecast SJM to deliver lower-than-peers growth of 3% per year in the long term. We upside to our fair value estimate could come from a clear demonstration of stronger execution after enhanced control of SJM by Pansy Ho and strong execution of the Grand Lisboa Palace.

SJM’s VIP gaming revenue was down 19% in the quarter, underperforming a 13% decline for the wider Macau market, as reported by DICJ. The group’s VIP rolling chip volume was down by a whopping 31% year over year, hurt by new VIP capacity in the market. SJM’s non-VIP gaming revenue was up 7% year over year in the quarter, underperforming DICJ’s reported 16%. Flagship Grand Lisboa’s VIP revenue and non-VIP gaming revenue was down 17% and up 3% respectively, also underperforming the Macau market.

Revenue at SJM was down 0.5% sequentially in the quarter. Adjusted EBITDA margin improved from 11.5% to 12.4% in the quarter. Adjusted EBITDA margin at Grand Lisboa was strong at 17.1% versus 13.9% in the fourth quarter, margin at other self-promoted casino was 19.3%, versus 14.8% in the fourth quarter; margin at satellite was 2.8%, versus 3.5% in the fourth quarter excluding an one-off provision against a receivable from a gaming promoter at Casino Eastern.

Construction of the Grand Lisboa Palace is expected to complete in the middle of this year, when SJM can start to submit applications for the opening of the resort. Management reiterated the timing of opening depends on government approval. We continue to expect an opening in the beginning of 2019. We don’t think there will be significant change to our fair value estimate should the resort open within several months of differences than our expectations.

Management indicated VIP business continues to be soft in April. Management expects the remaining 20 applications for VIP smoking rooms to be approved before the third quarter of this year. SJM and its sub-concessionary MGM China have extended their license to operate to 2022, same as its peers.