This top performing stock is the gaming industry’s best kept secret

NagaCorp is the largest gaming and leisure operator in the Mekong region. Protected by a long lasting competitive advantage and a favourable operating environment, it has managed to deliver an annualised return of 16% since its IPO. Here’s why we think it can go even further.

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  • Published on 16 Oct 2019

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NagaCorp is the largest gaming and leisure operator in the Mekong region, with a license to operate in Cambodia until 2065.
The company also holds a monopoly license, which safeguards its position as the only casino operator within a 200km radius of Phnom Penh up till 2035.
The addition of Naga 3 is expected to boost the company’s gaming revenue, the segment which contributes to the majority of NagaCorp’s top and bottom line.
With the number of visitor arrivals expected to skyrocket, NagaCorp is well in place to reap the rewards of Cambodia’s booming tourism industry.


Whenever people talk about gambling, the first few places that come to mind are big city destinations like Las Vegas, Atlantic City and Macau. Wandering the streets of these world class gambling destinations, one can easily find plenty of establishments operated by gaming industry heavyweights such as Las Vegas Sands Corp (NYSE:LVS), Galaxy Entertainment (HKEX:27), Wynn Resorts (NYSE:WYNN), so on and so forth.

On aggregate, casino and gaming stocks (measured by the MVIS Global Gaming Index) like the ones mentioned above have had a pretty good year so far, with share prices rising close to 15% (as of 14 Oct 2019). One company in particular, NagaCorp (HKEX:3918), has beaten nearly all its peers by recording an astronomical gain of 58% across the same period (Figure 1).

NagaCorp is the largest gaming and leisure operator in the Mekong region. Unlike the larger casino operators whose presences are in major resort cities, NagaCorp’s existing operations are concentrated solely within Phnom Penh, the capital city of Cambodia where it owns and manages NagaWorld, the only licensed casino in the city.

Figure 1: NagaCorp’s shares have risen by more than three times the industry average year-to-date


40-year monopoly status an unassailable economic moat

NagaCorp began operating in Cambodia back in 1995 when the company won a bid to build an infrastructure-tourism development in the Sihanoukville region, located in southern Cambodia. Together with the project, the company was awarded a 70-year gaming license – expiring in 2065 – to operate casinos in the country.

The gaming license comes with several perks, most notably the freedom for NagaCorp to decide on the number and type of games, as well as the operating hours of its premises without the need for any additional approval from the government. This high level of flexibility allows the company to optimise its operations over time, customising them to suit the changing demands of its customers.
 
In addition to the 70-year gaming license, NagaCorp also holds a 40-year license that grants the company exclusive rights to operate casinos within a 200km radius of Phnom Penh up till 2035. Protected by this monopoly license, NagaCorp has been able to deliver an impressive revenue growth rate of close to 30% since its IPO in 2006 (Figure 2). With practically zero competition, we expect NagaCorp’s stellar financial performance to persist for the foreseeable future. 

Figure 2: Stellar revenue growth driven mainly by NagaCorp’s gaming segment 


Higher gross gaming revenue expected with the addition of Naga 3

NagaCorp has two main business segments, casino operations and hotel & entertainment operations. The casino segment is the company’s bread and butter, making up 97% of its total revenue in 2018, while the remainder is contributed by the hotel & entertainment segment (Figure 2). 

Like all the other casinos around the globe, NagaWorld makes money by retaining a portion of the total bets wagered, after paying out all winning bets. This is known as net wins and it is usually positive due to the statistical advantage casinos possess in each game. Put simply, the odds of the casino winning your money are greater than the odds of you winning the casino’s money, which is why casinos are such profitable businesses.

The sum of all net wins produces the gross gaming revenue (GGR), a key metric used to assess the profitability of gaming companies. NagaCorp’s 2018 GGR grew by a massive 66% year-on-year to hit USD 1434 million, driven mainly by the opening of Naga 2 in late 2017 which more than doubled its total gaming capacity.

The group currently has a total of four projects in Phnom Penh, three of which have already commenced operations, while the fourth is currently in the advanced stages of planning (Table 1).

Table 1:  Summary of NagaCorp’s projects in Cambodia 
Naga 1 NagaCity Walk Naga 2 Naga 3*
Launch Date Dec-16 Aug-16 Nov-17 2025 (expected)
Project Type Integrated casino and hotel Underground duty free shopping mall Integrated casino and hotel Integrated casino and hotel/condotel
Floor Area (sqm) 113,000 13,000 108,000 544,000
Gaming Capacity 250 gaming tables, 1700 EGM - 300 gaming tables, 2500 EGM 800 gaming tables, 2500 EGM
Hotel Capacity  700 rooms - 900 rooms 4,720 rooms
*Currently in development
Source: Company Data, Moody’s Investors Service, Morgan Stanley Research

Two of the existing projects, Naga 1 and Naga 2, are integrated casino and hotel complexes, boasting an approximate combined total capacity of over 500 gaming tables, 4,200 electronic gaming machines (EGM) and 1,600 hotel rooms. The two are connected by a third project, NagaCity Walk, which is an underground duty free shopping mall. 

Slated to be operational by 2025, Naga 3 is the group’s latest expansion project, consisting of a third integrated casino, hotel and condotel. When completed, Naga 3 is projected to more than double the total number of gaming tables NagaWorld currently has, along with an additional 2,500 EGM and a colossal 4,720 hotel rooms. Naga 3 will also be linked to the rest of NagaWorld via NagaCity Walk, creating a one-stop entertainment hub in Phnom Penh’s premier riverfront district.

Similar to Naga 2, the company expects the addition of Naga 3 to provide a huge boost to its GGR, and also contribute to the long-term earnings growth of the group. Besides gaming, Naga 3 also offers a wide array of facilities and services that cater to the meetings, incentives, conferences and exhibitions (MICE) industry, capitalising on Cambodia’s fast-growing tourism sector.

Rising visitor arrivals a key catalyst for future growth

Due to the nature of the gaming and hotel industry, as well as a gambling ban that applies to all Cambodian citizens, NagaCorp’s revenue is largely dependent on the number of international visitors that patronises its establishments. Fortunately, the number of visitor arrivals to Cambodia continues to grow strong, with a record high of 6.2 million international visitors entering the country in 2018, representing a year-on-year increase of 10.7% (Figure 3). The country aims to bring in 12 million tourists by 2025. 

The influx of tourists has also led to higher hotel occupancy rates over the years, a positive for the entire tourism industry and especially for NagaCorp, because of the strong foothold it has in Phnom Penh’s tourism and entertainment scene. As of March 2019, NagaWorld’s hotel occupancy rate stood at 86%, higher than the nationwide average of 72%.

Figure 3: Sharp rise in the number of international visitors a positive for NagaCorp


A closer look at the statistics published by Cambodia’s Ministry of Tourism revealed that the sharp rise in total visitor arrivals was driven mainly by a surge in the number of travellers arriving from China. In 2018, the number of Chinese visitor arrivals nearly doubled from a year ago, and now accounts for roughly 33% of total visitors. Unsurprisingly, Chinese gamblers form the bulk of NagaWorld’s patrons.

Moving forward, we believe that the growing number of Chinese gamblers will be a key source of revenue growth for NagaCorp, as more of them are skipping Macau and looking towards nearby overseas gambling destinations such as Phnom Penh, partly driven by Beijing’s crackdown on gambling and corruption. 

NagaCorp also has agreements with several Macau based junket operators to attract more Chinese high rollers to visit NagaWorld, a move which will likely boost the casino’s VIP gaming revenue, which accounted for 72% of total revenue in 2018 (Figure 4). 

Figure 4: VIP gaming revenue forms a significant portion of the group’s total revenue


Investment risks

NagaCorp’s competitive advantage hinges upon its ability to remain as the sole casino operator in Phnom Penh. Therefore any disruption to the country’s political environment/corporate governance issues that could potentially lead to changes in gaming regulations, such as permitting new competitors to enter the market may threaten the company’s monopoly status and the sustainability of its future earnings. 

However with the political environment stabilising after the latest election, we are confident that the likelihood of such a drastic change taking place is extremely small, considering the fact that the Ministry of Economy and Finance of Cambodia has just reaffirmed its commitment to honour the existing agreement it has with NagaCorp as recently as 2014. 

Being a part of the consumer discretionary industry also means that NagaCorp is susceptible to broader economic risks, such as a global economic slowdown which may dampen consumer confidence and lead to a reduction in discretionary spending.   

The growing number of border town casinos around the golden triangle may also lure customers away from NagaCorp, but we think the impact should be minimal as these smaller casinos mainly cater to players from neighbouring countries looking to bypass local gambling laws, while NagaCorp generally targets the high end market. 

That being said, NagaCorp also faces competition from its regional peers such as Singapore and Malaysia, both of which are also in the high end gaming segment. However, NagaCorp’s close proximity to China is a key advantage that its competitors do not have. 

NagaCorp is also subjected to key man risk, with the founder and CEO Tan Sri Dr. Chen Lip Keong holding 66% of NagaCorp's shares. However Dr. Chen's substantial stake in the company can also be an indication of his confidence in the business, as he is also funding half the capex needed for Naga 3. 

Sound fundamentals accompanied by attractive valuations 

Besides its long-lasting monopoly status and the favourable outlook for Cambodia’s tourism sector, NagaCorp’s balance sheet is also healthier than its regional peers. As of June 2019, NagaCorp (HKEX:3918) has a debt-to-equity ratio of approximately 20%, much lower compared to its peer median of 110% (Table 2). 

Its interest coverage ratio of 18.4X is also substantially higher than its peer median of just 6.6X, indicating that the company has a better ability to service its interest payments. In terms of profitability, the group recorded an impressive net profit margin of 27.5% in 2018, on the back of an average 18% EPS growth rate over the past five years. 

Table 2: NagaCorp’s fundamentals are one of the best among its peers 
  Net Debt-To-Equity Ratio (%) Interest Coverage Ratio (x) Net Profit Margin (%) EPS 5 Year Average Growth Rate (%)
NagaCorp 10.6 18.42 27.49 18.05
Sands China 110.97 8.39 23.88 0.96
Galaxy Entertainment -10.49 69.84 25.48 17.48
Wynn Macau 1138.53 4.8 14.8 7.94
MGM China 138.98 3.42 9.05 -13.72
SJM -10.69 4.72 9.83 -7.51
Median 60.79 6.6 19.34 4.45
Source: Bloomberg, iFAST Compilations

Despite having better fundamentals than its peers, NagaCorp trades at a significant discount to them (Table 3). We believe that the discount is mainly driven by the fact that NagaCorp’s operations are concentrated solely in Cambodia, a developing nation where gambling is probably not the first thing that comes to mind.

Table 3: Compared to its peers, NagaCorp’s valuations are undemanding
  2020 Estimated PE Ratio (x) PB Ratio  Estimated Dividend Yield (%)
NagaCorp 13.43 4.49 4.83
Sands China 16.07 10.93 5.74
Galaxy Entertainment 15.92 3.24 2.13
Wynn Macau 13.26 39.5 6.78
MGM China 14.86 4.73 2.68
SJM 16.55 1.59 3.76
Median 15.39 10.74 4.29
Source: Bloomberg, iFAST Compilations

However, we believe that with rapid economic progress supported by a booming tourism industry, NagaCorp is well in place to benefit from the rising number of tourist arrivals. In addition, the company is also diversifying beyond Cambodia, with plans to open a casino in Vladivostok, a port city Russia’s Far East.  

From an earnings perspective, we believe NagaCorp’s stock is undervalued, trading at just 13.4X 2020 earnings vs. our estimated fair multiple of 16.5X derived from the Gordon growth model. This translates to a target price of HKD 16.5 and an upside potential of close to 25% (as of 16 Oct 2019). 

Our key assumptions include:
Cost of equity at 10.2%
Dividend payout ratio of 70%
Growth at 6%

Although the growth rate may seem rather steep, we think that it is entirely reasonable if we factor in Cambodia’s fast growing economy and the competitive edge NagaCorp possesses. The company’s fair multiple of 16.5X is also in line with its frontier market status, as its emerging market peers are trading at approximately 17.1X. 

That being said, we do see the potential for multiple expansion as the country progresses, especially when more tourists begin to recognise Phnom Penh as a prime gaming destination in Southeast Asia. This would certainly support share price appreciation in the long-term. Income seeking investors will also be happy to hear that NagaCorp has an attractive estimated divided yield of 4.83%.

Figure 5: Over the long run, share prices are driven by earnings


Table 4: Strong earnings growth for NagaCorp expected
  2018 2019E 2020E 2021E
Forward PE Ratio 12.8 14.77 13.49 11.81
Expected Earnings Growth (%) 13.35 28.68 9.88 14.04
EPS (HKD) 0.71 0.91 1.00 1.14
Source: Bloomberg, iFAST Compilations

All in all, we think that NagaCorp (HKEX:3918) is a fantastic long-term investment for investors who are looking for new ideas within the gaming industry. A long lasting economic moat, rising visitor arrivals, upcoming expansion plans and sound fundamentals are key reasons why we believe NagaCorp is poised to do well in the medium to long term. 


This article was updated on 21/10/2019 to include key man risks.


Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.


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