Macau Casinos Still Not a Great Bet in 2015

Fans and followers of casino socks shouldn't count on a gambling recovery in Macau anytime soon

A year ago, Macau casinos were raking in money hand-over-fist. Gaming revenue grew a whopping 18% in 2013, reaching $45 billion after the gambling enclave’s revenue grew 13% the year before.

macau casinosCasino stocks like Melco Crown Entertainment Ltd (MPEL) and Sands China Ltd. (SCHYY) — both with a major stake in Macau — were soaring too, with investors certain the region’s gambling growth would never stop.

Nothing lasts forever, however … even sure things like Macau’s gaming industry.

After years of phenomenal growth, last June, Macau casinos collectively posted a 3.7% decline in year-over-year revenue. At first it was dismissed as nothing more than the result of would-be gamblers being distracted by World Cup soccer.

But after six more consecutive months of declining year-over-year gaming revenue, (with the most recent month doling out a jaw-dropping 30% plunge,) it’s difficult to chalk things up to just a little volatility. Macau casinos and their corresponding casino stocks are back-pedaling here, and 2015 may not offer any relief.

Macau Casinos Hit a Wall

To put it bluntly, Macau casinos — and the analysts who recommended Macau casino stocks — didn’t prepare for the one contingency that could hurt the region’s gambling industry the most: greater regulatory oversight that has kept high-rollers away.

Though government crackdowns on China’s gambling industry feel like a relatively recent development, they’re not. That effort (led by Chinese President Xi Jinping) actually began in July, but wasn’t even specifically aimed at Macau casinos at the onset. Macau was simply the place where too many government officials and other high-powered businesspeople were able to flaunt their ill-gotten wealth, and where necessary, to launder money.

Macau’s place as the hub of such corruption was crystalized after a corruption-based arrest in the summer.

Specifically, Politburo Standing Committee member Zhou Yongkang and a couple of family members became the subjects of investigation for corruption in July, making Jinping’s threats very real. Arrests were on the horizon too, sending other guilty parties scurrying.

The end result was an 18% plunge in last July’s year-over-year revenue raked in by Macau casinos, as former VIP gamblers began to lay low and hopefully steer clear of jail. As it turns out, they’re still steering clear.

Simultaneously, China’s government began to put serious restrictive pressure on junket companies, which may have taken an even bigger toll on gambling revenue.

Junket companies are organizations that recruit gamblers, send them to Macau to gamble with other people’s money, yet hold the gambler personally responsible for losses. Think organized-crime-meets-loan-shark. While not illegal on the surface, it’s an arrangement that invites and often incites criminal activities … the kinds of activities Chinese officials stopped turning a blind eye to in mid-2014.

Junket companies are closely tied to the fate of Macau casino stocks because junkets drove an estimated two-thirds of 2013’s revenue for Macau casinos.

Between tighter junket scrutiny and crimped corruption, the region’s overall gaming revenue fell another 6% in August, and VIP revenue — junket-based revenue — fell 17% that same month following a similar plunge in July.

2015 Outlook for Macau Casino Stocks

The dark clouds of greater government scrutiny are foreboding, but some believe relief may be on the way…. even if only by default.

Assuming the crackdown that went into effect in June of last year isn’t altered for better or worse in the meantime, the wave of year-over-year revenue declines should run its course by the end of May. Union Gaming Research reports January’s and February’s gambling revenue will show pullbacks similar to December’s big dip.

Though growth may remain crimped a couple months from there, May’s end of tough comparisons will be followed by a wave of new casino openings in the second half of 2015 and 2016. Galaxy Entertainment (GXYEY), Las Vegas Sands (LVS), and Melco Crown Entertainment are all building new Macau casinos. While greater capacity won’t fully restore the enclave’s VIP/high-roller business, it will increase the region’s total gambling revenue capacity.

Still, owners of casino stocks may want to keep their Macau growth expectations in check indefinitely.

Investors have made the mental adjustment for newly-missing VIPs and high rollers in Macau casinos, and are now hopeful that China’s budding middle class can fill in the growth gaps. That’s not the best of bets at this time, however. See, China’s economy isn’t humming. The nation’s central bank finally cut interest rates by a quarter of a point and stepped up its bond-buybacks in November in hopes of spurring growth after a prolonged soft patch.

Even so, many analysts aren’t expecting the measures to work well enough to spur middle class consumption. JL Warren Capital’s Ana Swanson, for instance, said ” the rate cut is a largely symbolic move with limited practical effect.”

With junkets on the defensive, corrupt businesspeople and politicians on the sidelines, and a middle class that’s unlikely to snap out of what some believe is a brewing recession for the country, Macau casinos and their corresponding casino stocks aren’t the great opportunities they were yesteryear.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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