In past articles, I have presented a bullish thesis on casino by calculating the present value of future streams of income. While the industry has struggled of late (it is down ~30% over the last 3 months), the secular trends are still solid. From the expanding middle class in emerging economies to growing interest in gambling, the cards have stacked up in favor of the major players Las Vegas Sands (LVS), Wynn Resorts (WYNN), and MGM (MGM). Moreover, analysts remain bullish on all three despite recent challenges. Below, I review the fundamentals of each company.
Las Vegas Sands
12 out of 13 recent revisions to consensus EPS may have gone down, but analysts are still forecasting more than 80% growth from 2011 to 2014 - an average of 26.7% per year! 3 out of the last 4 quarters have been better than Street expectations; but, if the company just meets expectations and trades at 16x multiple, the stock will be worth $91.21 per share by 2016. A 10% discount rate would yield a $56.63 price target - thus providing a more than 40% margin of safety. At the same time, management has shown confidence over the fundamentals by offering a generous dividend yield.
The disappointing news stems from China - which hitherto has all been good news - where Macau growth is decelerating and Cotai Central development is sluggish. It is particularly disconcerting that Macau growth would slow, because it would seem to suggest that LVS is cannibalizing its business. In Singapore, it is looking like the government will tighten regulations to the Casino Control Act. However, this has been priced too much into the stock, which has fallen 11.7% over the last month. Trend-setting design additions to the new Macau property will also improve brand value.
If you decide to invest in LVS, you ought to be aware of the company's risk. With a beta of 3.6, the casino chain is one of the most volatile stocks on the NYSE and thus likely to generate either high or low returns in a short month's notice. But, in the long-term, the company almost certainly will go up from an improving global economy and Asian stimulus programs.
Wynn is another top brand in the casino business. It trades at a respective 20.4x and 14.2x past and forward earnings with 16.1% annual EPS growth expected over the next 5 years. This compares to corresponding figures of 21.1x, 12.9x, and 26% for LVS. Thus, I mainly recommend Wynn as a way to diversify. Unlike LVS, its PEG ratio is greater than 1, which indicates investors have at least somewhat factored in future growth. Since the bar has been set low, however, Wynn may outperform from a risk-adjusted standpoint.
There are several reasons to be bullish on the company. Softer-than-expected growth in Macau and loss of VIP share may be disappointing, but competition is not nearly as intense as the bears make out. Wynn has a powerful brand name that will appeal even more when the global economy recovers. More fundamentally, the company has just finished nearly a decade worth of development and is about to enjoy the fruits - possibly giving back in the form of a more shareholder-friendly capital allocation policy. Its properties are also regarded as the highest-end in both Macau and Las Vegas, hence potential outperformance in a recovery.
On a more general note, I believe that the bears have discounted the stock too much from slowing growth in Macau. The region is nowhere near maturity and has generally adhered to a free market economy that will attract capital and, likely, more gambling along with it. Management is still development Cotai, and it should help generate cross revenue opportunities by improving brand image.
MGM is the riskiest casino investment to make in light of how it is regarded mostly as a turnaround investment. Analysts expect losses to decline 19.6% to -$0.45 in 2012 and then by 66.7% before returning to positive territory. Progress is, however, heading in the right direction with double-digit growth on both the EBITDA and bottom line in 2011. And, despite earnings uncertainty, the company was still free cash flow positive at $374M last year.
The disappointing over slowing growth in Macau also applies to MGM, and the recent sell-off, again, suggests that now is a good buying opportunity for those who were formerly "on the fence". Las Vegas, which MGM is more a beneficiary of than many peers, is recovering with improved room rates and convention volumes. In terms of risk, the company is also improving its balance sheet by taking measures to cut back on debt.
Going forward, management should cut back on both capital expenditures and renovation expenses. Investors are still wary about the "going concern" reference in the 10K, so MGM is likely to outperform more if financial shape improves than if just operations improve. Leverage has fallen from 13x in 2010 to 8.7x in 2011's end, but more progress needs to be seen before shareholder value can recover.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.