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THE top and bottom lines of number forecast operators (NFOs) could be impacted by the implementation of the Goods and Services Tax (GST) in April.

lotteries_22_1053The GST Act 2014 stipulates that the supply of services related to betting, sweepstakes, lotteries, gaming machines or games of chance will be subject to GST. According to the formula in the Act, GST will be imposed on the net amount received on NFO sales after deducting taxes and duties, and the prize payout ratio.

Currently, the highly regulated industry is subject to a gaming tax of 8% on gross sales and pool betting duty of 8% (taxed on net sales). It also contributes 10% of its pre-taxed profits to the National Sports Council. Apart from that, it pays corporate taxes.

PricewaterhouseCoopers Taxation Services Sdn Bhd executive director Raja Kumaran says, what this essentially means is that GST could cause a reduction in the prize payout as the actual value of the wager could be lower than what it is now — a prize payout is dependent on the amount placed on the bet.

GST, a consumption tax, would have a direct impact on punters, who may shift to illegal betting because of the higher prize payouts from illegal NFOs.

In a recent report, Maybank Investment Bank Research notes that illegal NFOs’ prize payouts are 10% to 20% higher than those offered by legal NFOs.

“If the NFOs are not allowed to increase the prize payout, its attractiveness will be reduced. This would drive punters to the illegal betting scene where they can get a higher prize payout because of the absence of tax,” says an analyst with a local research house.

PwC’s Raja opines that other taxes imposed on the industry, such as the gaming tax, should be reduced correspondingly when the GST is introduced. “This would be fairer for the industry,” he adds.

Maybank IB Research says in its report that the NFOs are already facing weak NFO-related sales due to poor consumer sentiment, which has caused punters to reduce the size of bets.

“The 6% GST that will be implemented from April 1 onwards is expected to weaken consumer sentiment further and therefore, threaten NFO sales again. Assuming no new games are introduced, the NFOs we spoke to (Berjaya Sports Toto Bhd (BToto), Magnum Bhd and Pan Malaysian Pools Sdn Bhd) are budgeting NFO sales/draw to soften by approximately 2% in 2015,” it says in the report.

For the third quarter ended Sept 30, 2014, Magnum’s revenue contracted 4.6% to RM669.99 million from RM702.39 million a year ago. Net profit was down 30% to RM45.42 million from RM64.77 million previously.

Alliance Research highlights that gaming revenue per outlet per draw for the third quarter fell 4% compared with a year ago due to lower ticket sales. This was due to the relatively unattractive prizes caused by the higher frequency of wins during the quarter, weak consumer sentiment and increased competition from illegal NFOs.

Although BToto (fundamental: 1.3; valuation: 0.9) reported an increase in revenue and net profit for the second quarter ended Oct 31, 2014, it was mainly boosted by revenue contributions from HR Owen, its franchised motor vehicle dealership.

But its NFO unit’s revenue was down 4.3% year on year due to reasons similar to Magnum’s (fundamental: 1.7; valuation: 1.2).

For the second quarter, BToto’s revenue increased to RM1.25 billion from RM866.88 million while net profit gained 20.6% to RM99.69 million.

Many wonder if the NFOs will be willing to sacrifice their margins by absorbing the GST element in order to protect their market share from illegal gambling dens.

When contacted, BToto declined to comment. Magnum could not be reached for comment.

If the NFOs absorb the GST element, Maybank IB Research estimates that their earnings before interest, taxes, depreciation and amortisation (Ebitda) margins would be trimmed by 120 basis points (bps) for Magnum and 150bps for BToto, while its earnings estimate for both will be cut by 10% on a full-year basis.

“If they do that [absorb GST], their bottom line will be affected. It looks like neither of the options looks good for the NFOs,” says an analyst.

With no way around this, the analyst says dividends could be affected should weak gaming revenue continue.

BToto has a dividend payout policy of 75% while Magnum’s is 80%. So far, both companies have been paying out dividends above their stated policies.

For the cumulative six months ended Oct 31, 2014, BToto declared a dividend of 11.5 sen compared with 10 sen a year ago. Magnum declared a 15 sen dividend, same as the previous year, for the cumulative nine months ended Sept 30, 2014.

“It is still a good dividend stock with high yield, especially now with the weakness in the share price,” adds the analyst.

The recent weakness in the NFOs’ share prices could be attributed to skittish investors due to the impending implementation of GST. However, analysts believe the weakness from such concerns has been priced into the shares.

Over the past year, BToto’s share price has slid 8.3% to RM3.40 on Feb 5. Over the same period, Magnum’s fell to a low of RM2.56 before rebounding to last Thursday’s close of RM2.79.

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Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Go to www.theedgemarkets.com for more details on a company’s financial dashboard.

This article first appeared in The Edge Malaysia Weekly, on February 9 - 15, 2015.

 

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