Gaming Industry is Poised for Recovery Despite Recent Challenges | Capital Group

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The Gaming Industry is Poised for Recovery Despite Recent Challenges

By Jim Kang
Capital Group Equity Analyst

After years of soaring growth, the gaming industry has endured a difficult stretch. A downturn in the Chinese territory of Macau, the world’s biggest gambling market, has weighed on the earnings and share prices of global casinos that operate there. Meanwhile, Las Vegas rebounded slowly from the last recession. Despite these challenges, I believe the long-term prospects for gaming companies are encouraging. The outlook for Vegas is brightening and the issues affecting Macau will likely dissipate over time. Recent weakness in certain casino stocks has created compelling values that should benefit client portfolios holding these companies as growth returns in the future.

For more than a decade, the gaming sector was paced by the rapid growth of Macau. Its emergence as an international gaming center paralleled the expansion of China itself, including a surge in the number of wealthy Chinese. Even as the recession following the 2008-09 financial crisis tripped up Las Vegas, Macau continued to flourish. At one point, its gambling revenue expanded by the total amount of the Las Vegas Strip each year. Even now, Macau’s $44 billion in annual revenue is seven times that of Las Vegas.

In the last year, Macau has been pressured by multiple forces that struck nearly simultaneously. The biggest was an anti-corruption campaign undertaken by the Beijing government. Designed to root out abuses among high-ranking officials and businesspeople, the effort has been longer and more aggressive than initially expected. That has scared away many legitimate gamblers, especially VIPs who don’t want to be seen wagering large sums for fear they may come under scrutiny. The crackdown has also strained an underlying system in which private operators funneled gamblers to Macau by arranging their transportation, lending them money to play the tables and collecting their debts afterward. Macau’s troubles were exacerbated by the imposition of tighter visa restrictions and a ban on smoking in most casino areas. Topping it off, the clampdown on fraud came just as the Chinese economy was slowing and its real estate market was softening, which cut into demand from mass-market gamblers.

New casinos and attractions will draw visitors to Macau.

Despite the near-term obstacles, I believe there are several important factors going Macau’s way. The most significant is that China supports gaming in Macau. It’s important to point out that the anti-corruption crusade stretches across all of China. It doesn’t target Macau or gambling itself. In fact, betting has long been an accepted part of Chinese culture and social life. Rather than do away with gaming, the Chinese government would like Macau to diversify its economy and lessen its reliance on the industry to avoid the type of volatility that has occurred lately. That would follow the paradigm set by Las Vegas, which has transitioned into a broad tourist destination that gets a significant share of its income from entertainment, nightclubs, restaurants and shopping.

Another reason for optimism is an expected rise in the number of hotel rooms and gaming tables in Macau over the next few years. The six licensed casino operators are developing more than $20 billion in new projects that will boost the number of hotel rooms by nearly 50%. Though it may seem risky at a time when gambling activity has been hampered, I believe that supply will drive demand. Even with Macau’s troubles, the average hotel occupancy rate is close to 99% on many nights. The additional rooms, combined with the introduction of more non-gaming attractions, such as a half-scale replica of the Eiffel Tower, will lure new visitors. Gaming has historically been a supply-driven market, and additional supply should spur demand. In other words, build it and they will come. This dynamic took place in Las Vegas, where visitor traffic and revenue expanded as new casinos were constructed.

Certainly, there are risks going forward, especially the uncertainty of Chinese government policy. It’s unclear when Beijing will begin to ease off its anti-corruption drive and gambling activity will pick up. Also, licenses for all six Western gaming companies will be up for renewal between 2020 and 2022. I expect that the government will require them to pay one-time fees and pledge to build out their non-gaming activities. But it’s impossible to know what will be required, especially if the renewals come at a moment of heightened political tension between the U.S. and China.

Over time, Macau will probably follow a trajectory similar to Las Vegas. Even as the anti-corruption campaign runs its course and high rollers return, the mass market will become increasingly important as Macau matures. Mass-market gamblers generate less revenue per person, but profit margins are three times higher because casinos don’t have to offer free rooms and other perks that are commonplace with VIP gamblers. That should result in a steadier level of growth in the future.

Las Vegas is benefiting from a pickup in the national economy.

As for Las Vegas, the outlook is improving. The city emerged slowly from the recession as the sluggish recovery in the national economy suppressed consumer confidence and discretionary spending. Until its own downturn last year, the expansion of Macau also siphoned off VIP gamblers who previously had jetted to Las Vegas. However, rising U.S. employment and lower gas prices are helping Las Vegas turn the corner, with the city reaching new highs in tourist traffic. Renewed confidence in the city’s prospects is demonstrated by a recent pickup in the building of new casinos.

Las Vegas is undergoing a fundamental shift in which it is becoming less dependent on gambling as demographic patterns evolve. Younger visitors, especially millennials in their 20s and early 30s, are less interested in blackjack and roulette than in nightclubs, day spas and restaurants. Though they don’t gamble as much, younger visitors tend to spend heavily on other forms of entertainment, providing a more stable income stream for casino and resort companies. That trend will become more pronounced as the U.S. economy gains steam and the Vegas convention business continues to grow.

Moving forward, the gaming sector will not turn around immediately. However, the long-term prospects are favorable, and I believe that select companies will experience significant sales and earnings growth over the next three to five years. Beyond that, the industry will generate significant cash flow as it continues to mature, which it can pass on to shareholders in the form of dividends. That should reward investors who have taken a long-term perspective.

Jim Kang is an equity analyst who covers casinos and gaming. Based in Los Angeles, he has 27 years of investment experience and has been with Capital Group since 1988.

The views expressed herein are those of the author and do not necessarily reflect the views of everyone at Capital Group Private Client Services. The thoughts expressed herein are current as of the publication date, are based upon sources believed to be reliable, are subject to change at any time and should not be construed as advice. There is no guarantee that any projection, forecast or opinion will be realized. Past results are no guarantee of future results. This material is provided for informational purposes only and does not take into account your particular investment objectives, financial situation or needs. You should discuss your individual circumstances with an Investment Counselor.