Buying MGM and Expecting a Surprise

| About: MGM Resorts (MGM)

Every few years I make a trip to Vegas and attempt to spend a week forgetting the financial markets and instead focusing on relaxation and gambling. Since I am a futures trader, it stands to reason that I like to gamble (with the probabilities in my favor). Las Vegas provides me an opportunity to do the same – using the probabilities in my favor when playing poker, blackjack and craps.

Now, I cannot control these games as much as I can control trading in the S&P 500, but any little help I can get from this “risk management” can keep me from losing big money. One of the places I stay when I am there is the MGM. It is a casino that I like and has everything I need. It may not be flashy like others down the strip but it does provide me the environment I am seeking.

So why am I adding MGM (NYSE:MGM) to my portfolio? Good question. I like MGM for two major reasons and neither includes Macau. The first is the surprise factor. The surprise in this case is to the analyst community and particularly those who have been on a downgrading mission over the past year.

The other is the potential for earnings surprise. Generally speaking, when the 5-year note is rising, gaming names tend to do well with earnings and EBITDA steady to rising. If the market is downgrading this name (along with others), chances are they are not looking for these metrics to beat. Thus, there lies the catalyst to break higher.

Fundamental Story
As I touched on in the opening, the fundamentals of MGM could be a bit understated by the analyst community. From my estimates, I believe the financials will see a rise in EBITDA margin to approximately 33.5% for 2006 and 34% for 2007. For earnings growth, I am looking at $1.92 for 2006 (28% YY) and $2.41 for 2007 (25% YY) vs. the market (via Yahoo) of $1.88 and $2.33 on respectively.

Based on PE’s of 21x for 2006 and 17x for 2007, I would estimate that the company is undervalued as the PEG’s are both under 1. I think there will also be an upside to revenue in 2007 – another fact the market is missing. A fair value based on the numbers above would be $53 for 2006 and $60 for 2007.

Economic Impact
If you look at the stock of MGM, it generally trades with the trend in the 5-year note. In short, a rising 5 year note has been followed by a rising MGM stock price, using the long term chart. As long as the short rate 13 week till bill remains steady to range bound, MGM (and other gaming stocks) should do well.

A significant rise in short rates may put a crimp into my belief that this stock can move higher but I don’t believe that is a risk on the short term (allowing for the breakout). All and all, I would say that the current rate structure is supportive for MGM to move higher.

Technicals

MGM put in a nice reversal last month from the lows and the intermediate term chart is also exploding higher from the power side of the equation. The doji reversal from the low part of the range is bullish as well. The move from here should be at least supported to the top of the range near 45 and if broken, argues for a move to the mid 50’s.

In short, I think there is about 20% upside from the 41.30 entrance in the price. The DM buy trend model has not fully reversed though in the past when a doji forms, the DM normally follows a month or two later. The DM sell side has moved down below the bottom line which shows a fall back in selling pressure.

Sentiment
Analyst opinion on this stock, according to Yahoo, is slanted to the downside for the most part. Of the last six moves, there have been 3 upgrades and 3 downgrades. Of the last 3 market calls, 2 have been downgrades.

In looking at the opinions, Morgan Stanley downgraded last fall from 43 in September and again this summer from 37. Harris Nesbit downgraded in January and upgraded in March taking a 2 point loss. From a short perspective, almost 7% of the float is short which makes this a particularly interesting one given the potential for short covering. As a result of the short covering and the analyst community’s contrarian trading ability with this stock, I feel that sentiment this supportive to my purchase.

Summary

I think MGM's story can summarized in one word: "Surprise". Given the support in the trend of the 5 year note, the sentiment among the analyst and short community and the cheap stock relative to growth, I am a buyer of MGM and have added it to my MIR 2 portfolio.

MGM 1-yr chart:



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