Galaxy (27.HK): Invitations are in the Mail

What’s New - GEG reported Q1 2015 results even before its audited 2014 annual report was released. Q1 revenues were HK$13.7bn, down 32%y/y and 15%q/q. Mass gaming revenues slid 15%y/y and VIP fell 40%. Adjusted EBITDA was HK$2.3bn, down 40%y/y and 14%q/q. EBITDA margins were 16.8%, 2.1ppts lower than a year ago, but up 20bps from the prior quarter. Net cash at the end of the quarter was HK$6bn. Starworld revenues fell 42% y/y and property EBITDA dropped 44%. Revenues at Galaxy Macau declined 28% while EBITDA declined 35%y/y. Hotel occupancy rate was 93% at Starworld and 95% at Galaxy. As expected, Q1 results were very poor. One positive was that EBITDA margins saw a slight increase on a sequential basis despite a material decline in GGR quarter to quarter.

Forecasts and Valuation - The outlook for gaming in Macau remains very negative. We estimate April GGR will drop 40%y/y based on the current daily run-rates through the first week of April, worse than March. We’re forecasting a 27% decline in industry GGR for 2015, below 2011 GGR levels. We are lowering our 2015 estimated EPS for Galaxy from HK$2.26 to HK$1.96 and our 2016 EPS from HK$2.56 to HK$2.29. We maintain our target price of HK$42/share based on a target EV/EBITDA multiple of 13.5X FY2016 EBITDA estimates of HK$12.5bn and net cash of HK$12bn. Our target price does not include valuation for Phases 3 & 4.

Conclusion and Recommendation - Invitations for the grand opening of Galaxy Macau Phase 2 (GMP2) and Broadway are in the mail. Applications for tables have been submitted. While the gaming floor space at GMP2 can accommodate 500 tables, we assume the DICJ will only provide 200 tables. GEG will have at its disposal roughly 750 tables across its existing properties to manoeuvre in order to ensure success at its newer properties. However, table allocation below 200 will likely be viewed as a negative for both Galaxy and the Macau gaming industry. Management noted mass drop and VIP RCT (i.e. game volume) has stabilized and showing some improvement over the past 3 weeks. This is providing some confidence for Galaxy heading into the opening of GMP2. The new openings should propel Galaxy into the #1 Macau GGR market share position by the end of the year. We believe Q2 2015 will be the bottom in terms of revenue level for Galaxy and we will begin to see a gradual improvement in GGR going forward. Our BUY recommendation on the stock is based on undemanding valuations, the best pipeline of growth versus peers and solid operating cash flows.

Downside Risks - 1) Worse than expected declines in gaming revenues; 2) Negative operating leverage in a declining GGR; 3) Changes in China visitor policies that could impact visitor growth in Macau. 4) Less than optimal gaming table allocation from the DICJ. 5) Full smoking ban on casino properties.