Compared with all other sectors heavily affected from the current economic woes, the travel industry might be one of the most hurt. With unemployment at an all-time high and huge looming debt problems, many people haven’t had the extra cash to spend on travel luxuries. Recently though, studies have shown that even during the recession, people have been spending more money on experiences than goods. People would rather go on that weekend adventure in Las Vegas, than buy a new plasma TV. Who does this help out? The travel industry, and one of our favorites is MGM Resorts (NYSE: MGM). Recent upbeat analyst upgrades have helped build confidence in MGM. Analysts upgraded MGM from Market Perform to Outperform across the board with 17 of 25 analysts recommending to Buy MGM. Price targets range anywhere from $15-$20 per share. We believe MGM will rise to $16 per share, a total yield of 78%.
Below are some details and reasons to invest:
MGM is becoming a serious player in Macau. For the past two quarters, MGM has had a 10-11% share of the gross gaming revenue (GGR) in Macau, versus a prior share of 7-8%. With six months at this level, we are using this market share as the basis for future projections. While share will come down somewhat as Galaxy and LVS open new properties, we assume it is off this new, higher base.
Macau makes all the difference. MGM's Achilles heel strategically has always been its lack of market diversification. Las Vegas, historically has accounted for 80% of EBITDA. However, the management team and CEO are looking to change this, exploring new ways to grow the MGM brand globally. The IPO launch of MGM China Holdings was an important inflection point. MGM’s share of this ventured soared from 1% to 51%. This is huge for many reasons. MGM holding 51% gives it control, allowing it to grow this brand and strengthen its prospects, something that is way more valued than earnings alone. MGM’s earnings have been greatly improving its market share by about 300 BPS along with upward revisions in market growth estimates to around 35%.
MGM’s huge opportunity in Macau, is growing from an inconsequential share of overall growth to a significant component of earnings. This growing component of earnings deserves a higher multiple as well. MGM China Holdings first began trading at around 13x EV/EBITDA based on market estimates, an attractive premium to the ~10x rating MGM gets in the U.S. As a result, it’s time we take MGM’s presence in Macau seriously. Projections based on past results show this great opportunity awaiting itself. Macau can lead to an underestimation of this casino’s future potential. The casino is roughly the same size as its competitor on the peninsula, the Wynn Macau. The problem is it’s never produced results like the Wynn. Look at the past comparisons between the two:
2008: MGM Produced ¼ of the EBITDA of the Wynn
2009: That number grew to 30%
2010: It grew again to 40%
2011: This year analysts project the MGM’s EBITDA will be 53% of the Wynn’s.
While in no way do we expect the MGM to surpass the Wynn, what it does show is a consistent improvement as it has finally grown to be an actual competitor.
The MGM has substantially enhanced its bottom-line prospects. We need to factor in that the Macau market is still growing and the Vegas market should start to bounce back. Market projections for Macau have increased to 35% for the year compared with only 17-19% in years before. The point is not that MGM can or will surpass the Wynn, just that it has finally improved to the point of being a very viable competitor with substantially enhanced bottom-line prospects. This growth rate compares favorably with Las Vegas, and along with the incremental market share, raises MGM Macau's contribution to over 20% of total EBITDA in 2014, from only 2% in 2008.
No longer is MGM relying on just Las Vegas. Investors have long been waiting for signs of a Las Vegas recovery to reassess MGM’s stock. From what we can see, Las Vegas should start to greatly improve over the course of the next few years, however we might not see a full recovery until 2014. As a result, given the seismic improvements of MGM’s opportunities in Macau, expect it to become a bigger driver for the stock.
Current valuations are very attractive even after you assess the risks in the market. MGM is a risky stock with a net debt-to-EBITDA ratio approaching 11x. Most of this is due to past debt and averted from some near-term risks, the company is very sensitive to economic changes, both in China and the U.S. Despite all these risks, the stock is currently trading at 11 times 2012 earnings, which seems relatively cheap to its future prospects, which take into account the new Importance of Macau.
Overall, Macau is worth keeping on the watch list for several reasons:
- Shares have fallen dramatically as of late. Since July MGM’s stock has fallen from $16 to $9 per share, total drop of 44%
- MGM has been gaining market share in Macau and prospects bode well for increased future earnings given investors have more faith in the company. Historically this stock has moved up in times it has gained market share in Macau.
MGM is a bounce play. While risky, it has a huge amount of potential with many analysts expecting a possible yield of 70%+. Wait for a pullback and jump in, as long as the recession doesn’t significantly worsen MGM should prosper.