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Japan-Based Universal Entertainment Downgraded To 'B+' On COVID-19 And Removed From Watch Negative; Outlook Negative

  • The COVID-19 pandemic is likely to continue exerting considerable pressure on the performance of gaming machine and casino company Universal Entertainment for the next six months.
  • Universal Entertainment's credit metrics are unlikely to recover quickly as we previously assumed, given the extended lockdown in Manila and deteriorating outlook for its gaming machine business in Japan.
  • We are lowering our long-term issuer and issue ratings by one notch to 'B+', removing them from CreditWatch with negative implications.
  • The negative outlook reflects our view that harsh business conditions, with continued travel restrictions and social distancing measures globally, will result in a chance of at least one-in-three that the company will be unable to keep its financial base and liquidity at levels commensurate with the ratings for the next six months.
TOKYO (S&P Global Ratings) May 1, 2020--S&P Global Ratings today said it has lowered its long-term issuer credit and issue credit ratings on Japan-based gaming machine and casino company Universal Entertainment Corp. (UE) by one notch to 'B+'. The outlook on the long-term issuer credit rating is negative. The ratings were placed on CreditWatch with negative implications on March 19, 2020, following the suspension of operations at the company's casino resort complex in the Philippines.
The resolution of the CreditWatch placement reflects the continuation of travel restrictions and social distancing measures that have been put in place globally, including in Japan and the Philippines. The downgrade reflects our view that the company's credit metrics are unlikely to recover sharply in fiscal 2020 (ending Dec. 31, 2020) as we previously assumed in our base case because of the impact of the COVID-19 pandemic. The government of the Philippines has announced an extension to the lockdown in the Manila metropolitan area, leading us to believe that operations are unlikely to resume swiftly at UE's Okada Manila casino resort complex near the Philippine capital. In addition, an increasing number of pachinko hall operators in Japan, which are the company's customers, have suspended operations under the country's state of emergency and at the request of local governments. We believe this will heap downward pressure on the performance of the company's gaming machine business in the second half of fiscal 2020 (July to December) and beyond.
We believe UE's operational performance will remain under strong pressure over the next six months, given that travel restrictions and social distancing measures will likely remain in place for some time in Japan and the Philippines. UE's earnings have already taken a severe hit from the suspension of operations at the Okada Manila complex, which generates about 50% of EBITDA. In addition, the company will likely suffer significant damage from the increasing closure of pachinko halls as this weakens their operators' financial status, as well as a possible delay in regulatory approval for new gaming titles. This is despite the company's established business relationships with major pachinko hall operators, and its leading position within the industry in terms of rolling out new models that comply with revised regulations.
Given the material deterioration in its cash flow generation, we now believe that UE's debt-to-EBITDA ratio for fiscal 2020 will likely considerably exceed our 3.0x downgrade threshold (excluding the effect of new leasing accounting rules at overseas subsidiaries). We previously expected the ratio to steadily recover to about 2.5x for fiscal 2020, supported by a material improvement in its earnings after the introduction of gaming machines that comply with new regulations and full-scale operations at the Okada Manila.
We have changed our liquidity assessment for UE to less than adequate. We view the upcoming refinance needs for its U.S. dollar-denominated bonds of US$600 million, or about ¥65 billion, as a potential risk factor in our credit analysis on UE amid the unfavorable funding environment. The bonds mature in December 2021. On the other hand, we also believe that the company's liquidity position may be able to absorb cash burns, even if the Okada Manila remains closed for the next six months, given its substantial cash on hand.
The negative outlook reflects our view that the challenging environment amid the pandemic will result in a chance of at least one-in-three that the company will be unable to keep its financial base and liquidity at levels commensurate with the ratings for the next six months.
We could downgrade UE if we believe any of the following scenarios will occur:
  • The downward pressure on its liquidity position strengthens as deteriorating earnings make refinancing uncertain.
  • Its debt-to-EBITDA leverage stays above 5.0x for fiscal 2021 (including the effect of new leasing accounting rules at overseas subsidiaries), due to a delayed recovery in its financial health.
  • The contracted land sale agreement of UE's investment affiliate, the proceeds of which we expect to be used for debt repayments and liquidity maintenance, fails to materialize or falls short of our expectation.
Conversely, we could revise the outlook to stable if we believe all of the following scenarios will occur:
  • Its debt-to-EBITDA leverage improves steadily to below 5.0x in fiscal 2021 (including the effect of new leasing accounting rules at overseas subsidiaries), backed by a recovery in the gaming machine business and resumption of operations at its casino resort complex. This could occur if the COVID-19 pandemic is contained, leading to an improved business environment in Japan and the Philippines.
  • The downward pressure on liquidity eases such that its liquidity sources over the next 12 months far exceed its liquidity uses.
  • The company secures refinancing of its U.S. dollar-denominated bonds maturing in December 2021.

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