By Chad Mollman
Concerns pertaining to the global macroeconomic environment and a possible hard landing in China have driven a 30% decrease in Las Vegas Sands' (LVS) stock price since April. While Sands' shares will face further pressure in the near future, we view the stock as attractive on a long-term basis.
We think this company is poised to outperform the broader market during the next 24-36 months because: (1) the stock is undervalued on both a discounted cash-flow and relative basis; (2) Sands is positioned as the leader in the fundamentally attractive Asian casino market; (3) it faces a lack of new competition in its three principal markets of Macau, Singapore, and the United States; and (4) the opening of its new casino and share gains in the Chinese VIP market are serving as near-term catalysts.
Sustainable Growth in Asia
On a discounted cash-flow basis, Las Vegas Sands currently trades at a more than 40% discount to our fair value estimate of $74 per share; on a relative basis, it trades at a next-year price/earnings ratio of less than 14 times, an unduly low multiple for a company we expect to increase sales and earnings per share at 14% and 27.5% compound annual rates, respectively, during the next five years.
Sands currently trades at a next-year P/E ratio slightly lower than that of Wynn Resorts (WYNN). In our view, Sands should trade at a premium to Wynn, as we expect it to grow faster in China during the next two to three years while Wynn loses market share.
Sands generates about 85% of its revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) from Asia, higher than both Wynn (approximately 70%) and MGM Resorts International (MGM) (about 20%). While we think Sands' sales growth in China and Singapore will be constrained by weakness in the global economy with considerable volatility in near-term results, we are maintaining our long-term outlook that the casino market in China and Singapore will grow at compound annual rates of 12%-15% and 13%-16%, respectively, during the next several years.
We expect growth in both markets to be driven by increased salaries and wages leading to higher discretionary spending; an increase in the number of middle-class and upper-class consumers; increased wealth among Asian consumers; and infrastructure investments in China and Singapore designed to support tourism. The Chinese and Singapore markets are underpenetrated, with annual visitation to Macau and Singapore at less than 2.5% of the total population, compared with approximately 10% annual visitation to Las Vegas in the U.S.
It's Not All Headwinds for Sands
Perhaps what is most remarkable about Sands (and rarely commented on) is that it faces no new meaningful competition in Macau, Singapore, or Las Vegas in the next several years. The Macau market is an oligopoly; Sands is one of six companies licensed to operate casinos in China, and no new properties are expected to open until 2016 as the Macau government is promoting a managed growth of supply. The Singapore market is a duopoly, and Singaporean law prevents granting any additional licenses until 2019. The credit crisis halted all construction on the Las Vegas Strip, with no major casinos expected to open until the latter part of the decade. With Sands facing this lack of new competition for the next several years, we expect revenue, free cash flow, and earnings to increase substantially - even in a difficult global economic environment.
There are a number of other near-term catalysts for Sands that may counter weakness in the global economy, especially the opening of the $4.4 billion Sands Cotai Central casino complex back in April. Along with its massive Venetian and Four Seasons hotels, Cotai Central gives Sands a dominant position on Macau's Cotai Strip. We think the company is now in position to take market share leadership in Macau from SJM Holdings (00880).
Sands also is poised to regain lost share in the VIP segment. Management has undertaken measures to improve and expand its VIP gaming network in China, add more VIP gaming rooms, and create a more favorable experience for VIP gamblers.
On the other hand, we think Sands' focus on mass-market gambling also positions the company well in China (the company generates about 75% of EBITDA from mass-market gaming), as we expect the mass market to grow faster than the VIP market for the next several years. We view growth in the mass market as more sustainable than growth in the VIP market, as it is driven more by increases in wages, discretionary spending, and the number of consumers in the middle class, while the VIP market is driven more by a wealth effect.
Looking Long Term
We recognize that the global economic environment stands as a headwind to Sands' growth, and there is a near-term risk that the stock tests its 2011 lows of $36 per share for the rest of this year. But we are making a long-term call on the stock being attractive, though it may take 24-36 months for our investment thesis to develop and lift the share price toward our fair value estimate of $74. Bear in mind that certain risks always loom, such as the ongoing bribery probe in China, regulatory matters, and the potential for Sands to overexpand into other markets like Europe.
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