by Howard Jay Klein
"They ran their heads very hard against wrong ideas, and persisted in trying to fit the circumstances to the idea instead of trying to extract the idea from the circumstances…"
Charles Dickens, from Great Expectations
Gaming shares have participated in the recent market rally across the board. Its message we believe was that the sector had been long hammered by negative news both here and in Macau and that signs of recovery were too numerous to ignore. Stocks in the sector were cheap.
1. US regional gaming markets were starting to show some lift with moderate improvements in revenue, and earnings.
2. A growing consensus was building among operators, officials and some analysts that the Macau market had probably come close to bottoming.
3. Many of the stocks we covered in earlier articles were extremely cheap in our view. Particularly we saw strong upsides in Wynn Resorts, Inc. (NASDAQ:WYNN) signally a strong buy last January 14 when the shares were at $59. We called it an $80 stock by Q 2 or 3 this year and it has outperformed our call already reaching $80 at this writing. For that reason we've upped our target for the Wynn shares to $125.
4. We were likewise strong long term conviction believers in Las Vegas Sands (NYSE:LVS) last November when the shares were selling at $44 and the Macau market was still staggering under 30%+ monthly yoy declines in GGR. We still set a $70 target for the stock by the end of Q2 this year. Since the current rally the market has bid the shares up to $47, slightly more than an 8% rise. We'll take a rise against a decline any day to be sure but we must confess to being remained puzzled as to why LVS has not rebounded much stronger than it has to date. Our own internal metrics, entirely based on a business model rather than pure financial markers indicated the shares should have traded by now to a range around $54. We foresaw some resistance forming around $60, but believed that by next month, the shares would break past it and hit around the low sixties. After Q2 earnings we saw LVS headed straight to a number to or reasonably above our $70 target.
So we decided to revisit our $70 target to see whether there was something we were not getting as to why, especially amidst the current rally, (whether it continues or not is anyone's guess of course) LVS was not responding stronger to upside market factors than it has. Clearly we understood there still remain large pools of skepticism about a Macau rebound-and not without justification to be certain. However netting out the positives VS the negatives of LVS' Q4 earnings results, we came down on the positive side and continued to believe it was mispriced relative to its prospects and on fundamentals.
The market appears to disagree with our bullish stance given the tepid upside move of LVS so far
1. Lots of investors guided by sentiment among many analysts posits that after the Chinese New Year spurt, Macau GGR would return to a less steep, but still a scary double digit level of decline. There's nothing to argue about in that presumption except that it is the clear result of a short-term mentality. Our call was and always has been that LVS is a long-term play that will hold significant rewards for conviction investors. And we may also add there was much sentiment that Chinese New Year would again show a downside yoy 2015 when the you know what hit the you know what early last year.
Instead, CNY visitation was up 4.7% to 1.07 million souls. GGR during Golden Week was US$737 million just about matching last year's numbers. Hotel occupancy was 93.4%. Our sources in the market believe that this month, GGR could for the first time, clock a yoy increase of 1.5% to 2.00% There is of course, a calendar issue. This is leap year, adding a day onto February and in effect, mortgaging that day from March. January 2016 GGR was down 21% against last February when the crackdown hit producing a 43.8% decline, roughly a 50% upside improvement. Average daily revenue was $78 million. Mass GGR was down only 6% yoy. That is why, among other reasons, both in Adelson and Wynn's earnings calls they characterized their outlook as feeling "a lot better" about the trending market situation in Macau.
One executive deep into the marketing end of the business there reported to me, "I think the continuing negative sentiment is entirely understandable, it just so happens that in my view it's totally wrong. The type of action I saw in mass play and by the way, in some places even in VIP, suggests to me that the next quarter's results could show a drop in year over year declines to the very low single digits or to actual upward moves. I'm no stock market ace, just a gaming guy. I go by what my eyes tell me, what customers tell me and reading the daily numbers I review shift by shift," said my source.
"The worst is over," he said, agreeing with much local sentiment. To put this opinion in context, I need to say that the individual quoted here is an ABC, in the jargon of Chinese people that stands for American Born Chinese. He was a New Jersey native, educated at Rutgers who had worked in both in Atlantic City and Las Vegas. He migrated to Macau in 2013-a boom year and has worked for two of the major operators there. He speaks three Chinese dialects fluently, Mandarin, Cantonese and Fujianese so nothing he hears from customers is lost in translation.
"I've come to know hundreds upon hundreds of customers since I've been here. We talk all the time. They sure as hell don't tell me where their gold ingots or cash boxes are buried," he laughed, "but have a gut sense of how they feel. A lot of the fear I saw in the eyes of people last year because of the junket thing is gone. Even the worried stock market talk is kind of out of the conversation now. People are just getting on with life. Coming here to play have fun is just part of life for them. I think we're looking at a much better year."
2. Las Vegas Sands investment in the market will reach $13 billion by the time Parisian opens. Yet that fact doesn't seem to impress investors who still maintain a bearish outlook on Macau. It implies that they think the market is overbuilt already, that the Chinese economy is headed toward the dumper this year, and that Adelson may well have overreached and will be in for a grim reawakening. That appraisal seems more resilient than I believe is supported by the facts. However I definitely understand its roots and am not dismissive of the tentative take on LVS shares' upside out of hand. I just think it's a view overdependent on too many static metrics of valuation.
In rebuttal one is prompted to ask this question of bears: Given LVS' strong cash position and manageable debt load one must presume it has no shortage of choices as to where to invest its money. In the US regional markets? It already has a footprint in Sands Bethlehem, PA, which is doing fine Yet, looming over the property at the moment is the possibility-only the possibility--- that New Jersey legislators will approve a loopy plan to save Atlantic City by authorizing two casinos across the Hudson River to tap into the metro New York market. That would undoubtedly trigger a counter punch from New York legislators to pop a casino at the New Jersey border. So the LVS investment in Pennsylvania is scaled to an up and downside that relative to Macau is modest and prudent.
Or as we have mooted before, LVS has plenty of options in Las Vegas. It can acquire legacy properties at a price. It could announce massive expansions of its two existing properties, or indeed build a brand new, third strip entry. In other words it could follow the MGM model of piling brick and mortar on top of more brick and mortar in a slowly recovering Las Vegas. Yet it doesn't, happily participating with two properties in any improvement that market will generate in the next two years.
We believe Adelson remains convinced that Macau is a jurisdiction that holds the best possible return on investment of other existing jurisdiction currently available on the globe. And I also strongly believe he has made a decision to be prepared and ready to move fast-if Japan legalizes gaming heading toward 2020. That would easily take a $2 billion number. And if it does, and if LVS becomes a player, there the ROI could be immense. So the LVS investment theme is to plant its business model wherever an integrated resort can be built amidst a powerhouse population demo with ongoing growth potential. Asia has the growth and the bodies.
An economist friend who has worked on China investment projects for nearly two decades recently told me she believed that within the next ten years or less, something around 250 million more Chinese citizens will enter the middle class-at various levels to be certain. Yet this new cadre will have for the first time, disposable income and within that context, become yet another pregnant marketing target for Macau casinos. As the company with the most rooms and the most total tables already on tap, LVS, with a dominant market share, can sustain strong returns.
The dividend history
There are still lots of investors on the sidelines skeptical about LVS's continuing commitment to dividends should the downdraft continue into high double digits. Here's a quick history of LVS dividends, which shows the trends in both good and bad years:
2016: Consensus estimates $2.42. Our call is for $2.75. What counts here is that despite the powerful headwinds blowing out of the junket crackdown, the smoking ban threat, the bearish performance of the macro Chinese economy, the governmental limits on the number of tables, LVS continued to be committed to dividends which currently offer a 6.8% yield.
So here we are: A $12 billion revenue company with a near $38 billion market cap at writing, offering a 6.8% yield on a business entering a slow, but fairly certain trend of market recovery in its key sources of revenue with manageable debt, and strong cash reserves remaining in a trading range that still reflects what we believe is a mispriced valuation.
Bear in mind we're not trivializing of bearish sentiment, just puzzled by it when you examine the real world factors that should usually determine the ultimate collective wisdom of the market as news evolves.
So what is the market telling us with LVS at $47?
A lack of conviction that the worst is over in Macau. The belief that the junket crackdown, the smoking ban to come, the government imposed limits on total tables assigned, and the ever more shaky Chinese economy will dampen any strong upside for LVS as the biggest player in that market.
Despite that view, we're sticking with our $70 call, suggesting that even at $47 the stock remains cheap enough to still offer investors rewards both in price gains as well as the strong commitment to dividends by management we have every expectation will move back up as conditions there improve.
About the author: Howard Jay Klein is a 25+ year c-level executive veteran of the casino industry and now a consultant to that sector. Due to that potential conflict of interest, his own portfolio of gaming shares are held in a blind trust for his children and grandchildren. He is not a CFA, but his observations are presented to offer investors a 360-degree view of gaming operators, their managements, their assets and operations. He uses his own metrics but does employ some standard measures as well to provide context for SA readers. He is the author of Mastering the Art of Casino Management and the publisher of The House Edge premium site on SA.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.