Las Vegas Sands: Don't Sell

| About: Las Vegas (LVS)
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Summary

The gaming industry remains strong.

DuPont ROE analysis shows improvements in total asset turnover and financial leverage.

Dividend coverage and interest coverage are still strong.

Happy New Year dear readers and fellow investors. May the best come to you in 2017. This is my first article of the year, and I hope that you enjoy it.

The casino industry continues to perform well despite the revenue decline from the Nevada casinos in November 2016 on a YOY basis. Over the past year, the S&P 500 (NYSE: SPY) has appreciated by 19.6%. Meanwhile, the "casino ETF" (NYSE: BJK) has slightly underperformed the S&P 500, rising by 19.51%. My investment style is to look for the outperformers in the sector. For instance, Las Vegas Sands Corp. (NYSE: LVS) and MGM Casino Resorts (NYSE: MGM) have appreciated by 51% and 43% respectively.

Despite the impressive return in the last year, LVS still has potential to reward its investors for the reasons that I will explain. After reading this, I encourage you to delve further in LVS and determine whether it is a suitable investment according to your risk tolerance and objectives.

The company, its earnings, and my forecast.

In brief, LVS main theaters of operation are in Las Vegas and Macao. However, the company also operates gaming facilities in Singapore and Pennsylvania. Regarding net income, LVS reported a decline from $3.58 billion in 2014 to $2.38 billion in 2015 resulting from a drop in revenue from $14.5 billion to $11.7 billion over the same period. The return on equity also decreased from 39% to $27%. To put these numbers in context, I would like to direct your attention to the DuPont ROE analysis. Note: to compute the total asset turnover ratio, I divided the year revenue over the average assets between two years. All other amounts used are the final quantities for the year. I have also included my earnings and ROE estimates..

Year (in thousands) Net Income EBT EBIT Revenue Assets Equity
2016*E 2,267,024 2,465,595 2,710,087 10,987,153 20,680,660 7,566,627
2015 2,385,697 2,621,882 2,841,475 11,688,461 20,987,421 8,417,987
2014 3,588,071 3,832,711 4,099,226 14,583,849 22,354,047 9,020,582
2013 2,954,676 3,143,512 3,408,243 13,769,885 22,724,264 9,500,529
2012 1,881,813 2,062,576 2,311,382 11,131,132 22,163,652 8,658,412
2011 1,883,119 2,094,823 2,389,887 9,410,745 22,244,123 9,439,152
2010 781,603 855,905 1,180,586 6,853,182 21,044,308 7,931,188

Despite the ROE decline from 2014 to 2015, ROE has increased at a compounded annual growth rate of 5.15% since 2011 from 21% to 27%. Total asset turnover and financial leverage are the contributors to the growth, exactly what we want to see. Operating margin has remained constant over the last five years at 25%. Also, tax burden and interest burden have not changed in the low 90s.

To project earnings for 2016, I looked at the latest quarterly earnings report. Total assets remained relatively unchanged for Q3 2015 on a YOY basis while equity declined substantially from $8.4 billion to $7.5 billion. Therefore, I expect an increase in financial leverage for 2016 to 2.73, up from 2.49 a year ago. Net revenue has declined by 6% during the first nine months of 2016, and if this trend continues, net revenue will hover around $11 billion, representing a total asset turnover of 0.53. We can also assume that tax burden, interest burden, and operating margins remain stable because they have not varied over the past five years. Hence, I expect that the return on equity should increase to 30%. Also, I expect LVS' net income close to $2.26 billion and EPS attributable to LVS at $2.28 using 794 million as the weighted-average common shares outstanding and 80% of the ownership of comprehensive net income.

Year Tax Burden Interest
Burden
Operating
Margin
Total Asset
Turnover
Financial
Leverage
ROE
2016*E 0.92 0.91 25% 0.53 2.73 30%
2015 0.91 0.92 24% 0.54 2.49 27%
2014 0.94 0.93 28% 0.65 2.48 39%
2013 0.94 0.92 25% 0.61 2.39 31%
2012 0.91 0.89 21% 0.50 2.56 22%
2011 0.90 0.88 25% 0.43 2.36 21%

Dividend coverage ratio

LVS recently declared a dividend distribution of $0.72, representing a dividend of 5.18% on an annualized basis. Therefore, you could include LVS in your income-oriented portfolio. Nonetheless, do not forget to consider the 1.95 beta in your risk tolerance analysis.

To analyze the sustainability of the dividend distribution, I tend to look at the dividend coverage ratio (DCR) as measured by the cash flow from operations divided by the dividends paid. While the DCR has decreased from 2013, it is still at 1.28. I will keep monitoring the DCR, and I will reassess the dividend sustainability if the DCR falls below 1.00 in 2016.

Year (in thousands)

CF from Op

Dividends paid

Dividend coverage ratio

2015

3,449,971

2,692,882

1.28

2014

4,832,844

2,386,657

2.02

2013

4,439,412

1,564,049

2.84

2012

3,057,757

3,442,312

0.89

2011

2,662,496

75,297

35.36

2010

1,870,151

93,400

20.02

Should we be worried about the increase in financial leverage in 2016?

The return on equity can improve significantly as the financial leverage increases in a firm. In the case of LVS, financial leverage is expected to increase in 2016 mainly as a result of declining equity. Long-term debt increased slightly, but not considerably as of Q3 2015. Therefore, to answer the question before, we could take a look at the interest coverage ratio (ICR), measured as the operating income divided by the interest expense.

Year (in thousands) Operating
Income
Interest
Payment
Interest
Coverage
Ratio
2015 2,841,475 265,220 10.71
2014 4,099,226 274,181 14.95
2013 3,408,243 271,211 12.57
2012 2,311,382 258,564 8.94
2011 2,389,887 282,949 8.45
2010 1,180,586 306,813 3.85

ICR was 10.7 for 2015, slightly down from 2014. However, do not be afraid of this decline as it is clear that LVS can meet its obligations to debt holders.

What other analysts think

Stifel and Telsey Advisory Group reiterated their bullish views in November setting their price targets at $65.00 and $60.00 respectively. These price targets represent returns of 18% and 9% from current price.

Investment risk

One of the threats for LVS and the casino industry, in general, is the passage of unfavorable laws. However, I do not foresee such event shortly. On the contrary, Japan is now considering opening its doors to casino gambling which represents an attractive opportunity for LVS to expand its market.

My two cents

The gaming industry remains strong. LVS is a major player, and its fundamentals are great. You can appreciate the financial stability and improvement of the company by the DuPont ROE analysis. Moreover, I expect ROE to increase this year to 30% despite a possible decline in revenue and net income on a YOY basis. The company offers an attractive 5.18% dividend yield, and the dividend payment is not at risk at this time. Moreover, the company can easily meet its obligations as we saw from the interest coverage ratio. In brief, this is a gem that should bring happiness to its shareholders.

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.