Given that it's illegal to gamble in China, Macau has been a popular destination for Chinese tourists for years. Not only is gambling legal in Macau, but the city has also transformed itself into an entertainment destination.
With Macau situated right next to some of China's richest provinces, casinos there attract a substantial portion of Chinese gamblers. While the gaming experiences available in Singapore and Las Vegas are comparable, they are much further away geographically.
It may not be widely known but Macau used to rely on the high-roller VIP crowd to power revenue growth, but lately the city has become more determined to court ordinary Chinese, also known as the "mass market" crowd, for sales.
This is a positive development trend for Macau casinos given that the mass market crowd keep growing as China's middle class expands. Not only this but the mass market is also a more sustainable revenue driver than VIP high rollers.
In terms of the mass market share, Sands China Ltd (SEHK:01928) is the leader at around 29.5%. Galaxy Entertainment Group Limited (SEHK:0027) is second at 18.7%, while Wynn Macau (SEHK:1128) has 12.2%.
Meanwhile, the Chinese economy has slowed recently. The trade tensions between the US and China have injected uncertainty into the economy, and the Chinese government's stimulus response has yet to turn the economy around. After years of growing at around 7%, China's economy could now grow at 6% or less.
Some economists think China's economy will only grow 6.2-6.3% in 2019 and many analysts have cut their GDP growth forecasts to below 6% for 2020. The dim outlook has caused the RMB to weaken. Before August, the RMB had never traded below the symbolic 7-level to the US dollar since 2008.
Due to the Chinese's government response to US tariffs, however, the currency now trades around 7.15 times to the US dollar. Some analysts think that the RMB could depreciate to as low as 7.2 times the US dollar and this can end up negatively impacting a lot of Chinese businesses.
How weak RMB plays out in Macau
Although a currency drop of 4% or 5% doesn't sound like much, it can matter a lot. Many businesses operate on net margins of 10% or less and a 5% decrease in sales for a business, with mainly fixed costs, could mean a decline in profit of around 50%.
Broadly, casinos fit the criteria of currency-sensitive businesses. They have high fixed costs due to the need to buy gambling licenses and the need to pay for expensive casino buildings upfront. Given that casinos in Macau derive most of their business from Chinese punters, a lower RMB means lower spending power for gamblers, which could translate to lower sales.
Indeed, as a result of the weaker RMB, as well as the slowing Chinese economy, and the social unrest in Hong Kong, Macau gross sales have weakened. In August, gross gaming revenue (GGR) for the gambling hub was 24.3 billion patacas (US$3.0 billion), down 8.6% year-on-year. In July, GGR in Macau also fell 3.5% year-on-year.
Given that "leisure" sectors tend to be economically sensitive, casino stocks depend a lot on the state of the Chinese economy. When times are bad or uncertain, consumers are less inclined to spend on discretionary items such as watching entertainment shows or gambling.
In the short run, Macau's casino stocks face negative exposure from the trade war and the depreciating RMB. If the RMB depreciates further – or the trade tensions worsen – Macau casino stocks might not do as well.
In the long run, though, Macau casinos benefit from the opening of the Hong Kong-Zhuhai-Macau bridge as well as the growth of the Chinese middle class. Macau casino stocks could still be solid long-term investments but investors will likely have to ride out volatility in the near term.
A version of this article originally appeared on our Fool Asia site. For more coverage like this head over to Fool.hk.en.