A Hedged Bet For Macau Casinos

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Includes: LVS, MGM, MLCO, WYNN
by: Investing Hobo
Summary

A slowing Chinese economy will limit growth for Macau casino operators.

Increased U.S.-China trade tensions could shift Chinese gaming tourism away from U.S. resorts.

A hedged position long Chinese casino and short U.S. casino would offer the safest bet while maximizing potential upside.

US-listed casino stocks did horribly in 2018 due to the slowing global economic outlook, especially for China, which had been a growth driver for gaming companies that operated in Macau. The three largest Macau-linked gaming stocks - Wynn Resorts (WYNN), Las Vegas Sands (LVS), and Melco Resorts (MLCO) - had impressive early 2019 rallies, but after President Trump escalated trade tensions with China by lifting tariffs to 25% on $200 billion worth of imports on May 5, 2019, all three crashed by 18.5%, 13.5%, and 20.5% respectively. Any increased possibility of a Chinese slowdown could affect tourist traffic to the region and thus affect these three casino operators that have high Macau exposure.

Melco Resorts is a Chinese operated company and derives all of its revenues from Macau. Justifiably it also had the largest drop of 20.5% since the May 5 tariff news. Wynn Resorts follows next with 75.7% of its revenues generated in Macau based on the latest quarter's figures. Las Vegas Sands had the least exposure of the three at 64%. The table below shows general valuation metrics for these three companies:

Company Q1 Macau Sales Debt / Cash Price / Book 2019 Est. PE
MLCO $1.36 billion 2.27 4.7 / share 20.55
LVS $2.33 billion 2.9 8.3 / share 17.73
WYNN $1.25 billion 5.06 17.9 / share 18.35

A simple summary of this table data suggests that WYNN is relatively in the weakest financial position while trading at the highest premium to equity. MLCO in contrast trades at a 74% discount to WYNN's price to book premium. While all three have similar price to earnings ratios, it's important to note earnings are not a valuable metric to use during cyclical downturns. If something were to go horribly wrong for the Macau gaming industry, WYNN is the most leveraged and also has the most to fall to reach book value. History backs this statement - in two of the largest cyclical declines for casino operators back in 2007/2008 and 2014/2015, WYNN dropped by as much as 91% and 80%, respectively, from its highs.

WYNN is also a better candidate over LVS because it recently posted relatively weaker Q1 2019 earnings as its two main Macau resorts Wynn Palace and Wynn Macau saw revenues decline by 9.1% and 15.3% year over year, respectively. In contrast, MLCO posted annual revenue growth of 3.7% and LVS grew revenues annually by 1.9% for the same period.

Other than an economic slowdown in China due in part to raising tariffs on its exports, investors in US companies with high exposure to China have another issue to worry about: Chinese consumer retaliation. Recent precedent include the Chinese boycotting of South Korean products due to their THAAD deployment in 2017. The most extreme consequence was Lotte Group, one of South Korea's top 5 conglomerates, completely pulling out of China earlier this year after already investing $9.6 billion in the country. Lotte Group saw its supermarket chain revenues drop by 77% following Chinese boycotts.

Trade tensions got worse last week after President Trump signed an executive order blacklisting Chinese telecoms, namely Huawei, from doing business in the US and with US companies. The specific targeting of Chinese companies has already enraged consumer sentiment in China and caused anti-US rhetoric to go viral on social media outlets. While the Korean THAAD boycott was political, trade issues with the US are economic and directly affect the spending power of Chinese consumers. Not only could this reduce gaming tourism to Macau but potentially cause Chinese gamblers to avoid US casino resorts altogether.

This is the worst-case scenario for US-listed Macao casino operators like LVS and WYNN and could be worse than the previous cyclical declines in 2007 and 2014. If trade tensions don't get resolved favorably from the standpoint of China, sentiment against US companies could change negatively without certainty of reversing. MLCO which is Chinese operated, might actually benefit from anti-US sentiment as revenue shifts from its US competitors.

Trade Strategy

If one believes increased US-China trade tensions will negatively affect Chinese consumer sentiment, there are three ways to play this trade:

  • Long MLCO in hopes of it gaining market share lost by US operators WYNN, LVS, and to a lesser extent MGM Resorts (MGM).
  • Short WYNN or LVS due to potential loss of revenue from Chinese gaming tourist. MGM only generates 23% of its revenues in Macau and should be excluded from consideration as a main target.
  • Engage in a hedged position with a long position in MLCO then shorting an equal position in either WYNN or LVS.

MLCO LVS WYNN chart

As seen in the chart above, all three stocks move in general unison. Thus a hedged position should be the first choice since it is the safest and minimizes the potential trade risk while also maximizing potential gains since both positions could diverge favorably for reasons described earlier. A hedged position could be started at any time, but one-way trades should refer to short-term technicals.

The near-term technicals for all three companies indicate a potential bounce could occur off the 200-day moving average. If a bounce off the 200-day MA does occur, near-term targets should be the 10-day MA and the 50-day MA as follows:

WYNN: $126 and $132

wynn chart LVS: $62 and $64

lvs chart MLCO: $21.50 and $23.50

mlco chart These points and any points in between the 10day MA and the 50-day MA would be ideal to exit longs or start short positions. For aggressive short tilted traders who already engaged in a long MLCO and short WYNN/LVS position, it would be a good chance to exit MLCO long if you believe the sector would likely continue moving together to the downside. Given all three stocks broke their 200-day MA that is still trending down, the risk is to the downside with potential retests of last December's lows.

Other than a hedged position, these trades are based on Chinese sentiment turning negative against the US. Thus it's critical to stay in touch with US-China trade news in case a full resolution is put into effect. In my opinion, while there may be 'talks' of trade relations improving that can spark short-term rallies, the actual 'action' between the two countries has been increasingly hostile. Macau revenue numbers for May and June, which are normally released early in the following month, will likely indicate that stabilization or a retest of last year's lows is in order.

Disclosure: I am/we are short WYNN. 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.

Additional disclosure: I am also long MLCO as a hedge against my short position in WYNN.