The Big Mo

High-flying Macau operations have plenty of upside in a downturn

The Big Mo

Momentum, by definition, is hard to break. We repeatedly see stocks that continue to climb after they have surpassed their fundamentals simply because they have momentum, and it is difficult for investors to separate themselves from the bullish spirit.

Likewise, there is downward momentum and, even as the numbers suggest stocks have become cheap again, it is hard for investors to run contrary to the trend.

When momentum does break and stocks go into reverse, it can be harder still to stop the new momentum as it races past the fundamentals in the opposite direction.

Thus it has been with Macau.

Just months ago, Las Vegas Sands and Wynn Resorts were hitting new highs as investors were told that the future is almost unlimited. Even with the rise of competing markets in Asia, Macau had penetrated just a fraction of the growing Chinese market, investors were told.

And when reasons ran out for justifying higher prices on even the most optimistic scenarios, new reasons were found. Then, Macau growth slowed. No problem. It would resume. The World Cup would end and remove its distraction from gamblers. China remained underpenetrated, investors were told.

Then revenues actually fell year-over-year for three straight months, and sequential growth moving through the summer was lower than historically true.

All of a sudden, that momentum, which was so irresistible, stopped and reversed.

Nearly as suddenly, all the issues pooh-poohed before had taken on significance:

• Tightening Chinese credit that could crimp junket operators.

• Chinese corruption crackdown also crimping VIP play.

• Rise of the same regional casino markets that had been dismissed before.

• Rising wage pressures that could force labor costs to rise double-digits for a while to come.

• Smoking is soon to be banned from the mass-market casino floor.

Even those bulls who see just a lull in growth until the new mega-resorts start opening next year might ask whether the huge new capacity represents the next growth wave or possible cannibalization.

The result: stocks slipped, then fled lower, and finally were routed.

As of this writing, Las Vegas Sands is down 29 percent from its 52-week high. Wynn is off 26 percent. Melco Crown 39 percent.

MGM Resorts, the last of the four U.S.-listed Macau operators, declined just 17 percent, but MGM is a different case. Rebounding Las Vegas is a much bigger part of its business. Macau is a much smaller part than for the others. And the debt-laden company has been improving its balance sheet materially.

So, the questions arise, are these stocks now cheap, and is the downward momentum pushing them into bargain territory?

As in any good debate, bulls and bears can both make good arguments.

We’ll side with those who say Macau can continue to grow. The infrastructure improvements to deliver people to the market are real. The development of adjacent Hengqin Island into a national Chinese tourism destination is real. There are signs that Macau is capacity-constrained, so new capacity can grow the market.

But we also think the days of break-neck growth could be over. New regional competition is real, as demonstrated by junket operators already taking customers to lower-tax markets such as Philippines and Cambodia where they can earn higher commissions. Russia, Australia, Korea, Vietnam and maybe Japan will be formidable and should not be dismissed, certainly not in their aggregate.

Macau wage pressures will raise expenses.

The Macau government can be expected to extract concessions from license renewal negotiations that could begin as early as next year.

And all of that expansion in Macau—4,300 tables and more than 13,000 hotel rooms on Cotai alone—will have to be absorbed, though the Macau government might force the casinos to pace their growth.

So, back to the question: Are the U.S.-listed Macau operators cheap?

The answer is yes, by several measures: relative to their past valuations, given their growth rates even assuming Macau slows, given that each has projects opening over the next two years, and given their strong cash flow and relatively low debt, except for MGM, whose debt remains high.

Look at some of the fundamentals:

Price to earnings growth ratios of 1 to 1.5 times is reasonable. If analysts are correct, Wynn is OK at 1.4 times, LVS cheap at just around 1 and MPEL a bargain just under 1.

Consider their balance sheets. At $1.9 billion in EBITDA, WYNN could be debt-free in just over two years—even without growth. LVS could be debt-free in just over a year, and MPEL in a matter of months.

Of course, they won’t be debt-free so fast as they are spending to build their new projects. However, those projects will provide growth for future debt reduction, higher dividends, share repurchases, or more growth projects.

Consider:

• WYNN will open its Macau mega-resort in a little over a year, nearly doubling its capacity there.

• LVS is still ramping up Cotai Central, will open its 700-room St. Regis hotel tower and has been awarded construction permits for the 3,000-room Parisian.

• MPEL is building out City of Dreams, will open Studio City in a couple of years, and is going international with Philippine and Russian projects.

• MGM will open a Cotai resort, dramatically increasing its capacity.

And consider total return. LVS and WYNN are generous dividend payers, and MPEL has just initiated a recurring dividend.

Finally, WYNN, LVS and MPEL are run by founding visionaries who have inculcated their values into their organizations. These companies are not going to collapse.

None of this means that stock prices won’t go lower. Again, momentum is hard to stop, and there definitely is downward momentum.

But the fundamentals, and a reasonable—not Pollyannaish but not overly bearish—outlook for Macau, suggest that if the bottom isn’t at hand, it’s getting near.

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