• U/G to NEUTRAL from Sell, new MYR1.13 TP (DCF) from MYR0.90, 2% downside. FY23 earnings and dividends exceeded our expectations, due to our previous conservative forecasts. We upgrade our recommendation as we see limited downside to valuations after lifting our forecasts. We believe number forecast operators (NFOs) will see a high degree of defensiveness thanks to the yields and relatively inelastic demand from punters.

• Above our expectations, but within consensus’. FY23 core earnings of MYR125.2m (+21.6% YoY) accounted for 113% and 95% of our and Street's full-year estimates. The deviation was due to lower operating costs despite above-average prize payouts. A fourth interim DPS of 2 sen (4Q22: 1.5 sen) was declared and will go ex on 12 Mar, bringing FY23 DPS to 6 sen (FY22: 5 sen) – exceeding our estimates.

• Results review. YoY, FY23 revenue rose 6.3% to MYR2.2bn despite a lower number of draws (2023: 165 vs 2022: 179), thanks to the continued recovery in ticket sales (FY23: 80% of pre-pandemic levels vs FY22’s 75%). FY23 EBIT margin expanded by 0.5ppts to 10.8% despite a higher prize payout (FY23: 65.6% vs FY22: 64.3%), attributed to lower operating costs (-20% YoY), which we believe was due to operational efficiencies from cost rationalisation efforts. QoQ, 4Q23 revenue rose 6.9%, thanks to the strong jackpot run (Figure 1). Together with a lower prize payout (4Q23: 63.3% vs 3Q23: 64.9%), core earnings rose by 71.4% QoQ to MYR39.9m.

• Outlook. We anticipate that sales in 1Q24F will experience an upswing due to favourable seasonal factors, particularly driven by the Lunar New Year period. However, the sales and service tax (SST) hike, which takes effect on 1 Mar, will increase the tax burden for NFOs. Our channel checks indicate that illegal NFOs are capturing significant market share in two northern states, which have been underserved following the closure of legal NFO outlets. We believe the NFO sector requires the legalisation of online gaming and/or stricter regulations against illegal NFOs to achieve a meaningful recovery and growth in ticket sales.

• Forecasts and ratings. Post results, we lift our Street-low FY24-25F earnings by 11-14% after imputing lower operating cost assumptions, and introduce FY26F (+4% YoY) earnings. Consequently, our DCF-TP is lifted to MYR1.13, implying 11.5x FY24F P/E (close to its mean). We believe the current at-mean valuation is fair, considering the lack of exciting catalysts for the sector.

• Key upside/downside risks: Favourable/unfavourable luck factor and policies, and higher/lower-than-expected ticket sales.

Source: RHB Research - 29 Feb 2024