Over the last 12 months, Macau casino gaming stocks are down by an average of 50% as the world’s largest casino-gaming market experienced an unprecedented decline in gross gaming revenues (GGR). GGR in Macau experienced its first yearly decline since data became publicly available in 2002, falling by 2.6% last year to $44 billion as a result of the Chinese government’s anti-graft movement, Macau’s hotel room constraints, and a slowing Chinese economy.
The first two months of 2015 was more of the same, with January-to-February 2015 aggregated GGR falling by 35% year-over-year. Many analysts subsequently revised their 2015 GGR forecasts to the downside. Fitch was the most optimistic, forecasting a -4% decline; JP Morgan forecasts an -18% decline, Wells Fargo a -19% decline with Deutsche Bank predicting a very bearish -30% decline.
Just earlier yesterday, the Macau government itself issued its forecast for a -32% decline in 2015 GGR as it plans to implement a full smoking ban and restrict visa issuances to better control the inflow of Chinese mainland tourists. Investors should note that Macau’s official government GGR forecasts have been highly inaccurate in the past.
We believe GGR in Macau will rebound by 2016 and that the weakness in Macau-based, casino-gaming stocks is coming to an end. Analyst sentiment is extremely bearish and stock prices have held up reasonably well, despite the bad news flow over the last several months. In particular, we like Las Vegas Sands (LVS). LVS has significant exposure to Macau gaming (about 65% of its 2014 net revenues come from Macau), but the firm’s operations are diversified with its remaining net revenues coming from Singapore (22%), and the United States (13%). Over the last 12 months, LVS is down by nearly 30%, but we find LVS to be a compelling value play for three reasons.
- 1. The GGR and economic outlook for both Macau and Singapore remain highly attractive
LVS is a dominant player in both Macau and Singapore. LVS is one of only six licensed casino operators in Macau (the only city in Greater China where gambling is legal). Within this $44 billion market, LVS has a 35% EBITDA (earnings before interest, taxes, depreciation and amortization) share in fiscal 2014, up from 32% in 2013. Within Singapore – where LVS’ Marina Bay Sands vies for market share with Gentling Singapore in a duopoly market – LVS holds a commanding 60% EBITDA share in fiscal 2014. LVS is still expanding in Macau. With the completion of the St. Regis Tower in August this year, as well as the opening of the Sands Parisian in 2016 – LVS will increase its number of hotel rooms to nearly 13,000, accounting for around 45% of the total Macau hotel room supply.
More importantly, we believe Macau is simply in a transition phase as the Chinese and Macau governments want to diversify Macau’s business to appeal to more mass-market traffic, which boosts higher margins in the long-run (as VIP traffic carries commission costs that are paid to junkets). LVS is responding by doubling the firm’s retail offerings to align with the government’s diversification strategy. Despite the recent Chinese economic slowdown, the country is still growing by 7% while the middle class is still expanding. In addition, both China and Macau are investing heavily in infrastructure that will allow Macau to boost its tourism capacity over the next several years. This includes the Macau Light Rapid Transit System—with its first phase to be operational by 2016 – which will serve Macau’s major areas as well as several major border checkpoints. The completion of The Hong Kong-Macau-Zhuhai Bridge in 2016 will reduce travel time between Hong Kong and Macau from four hours to 40 minutes and subsequently draw more tourist traffic as well.
- 2. Favorable supply and demand dynamics in the U.S.
LVS’ U.S. revenues (comprising of the Venetian Resort, The Palazzo, the Sands Expo and Convention Center, and the Sands Resort Bethlehem) declined by -1.6% to $2.0 billion in fiscal 2014 due to overall GGR weakness on the Las Vegas Strip. While gambling revenues are still under pressure due to increasing competition from other parts of the country (e.g. according to the Casino City’s Indian Gaming Industry Report, California’s 68 tribal casinos – the most in the nation – yielded $6.96 billion in revenues in 2012), we believe the Las Vegas Strip, and LVS’ properties, remain the destination of choice for those seeking premium accommodations, world-class gaming and entertainment, and top restaurants. The Las Vegas Strip also remains a hugely popular destination for business conventions.
With U.S. job growth exceeding expectations, as well as lower travel (fuel) costs, we believe LVS’ U.S. revenues would tie more closely with real GDP growth (about 3%) this year.
- 3. LVS’ valuations are attractive
LVS is trading at an EV/Last 12 Months EBITDA multiple of 10.2, which is 29% cheaper than its 14.3 three-year average multiple from 2012-2014. Note that despite the slowdown in Macau last year, LVS grew both its revenues (by 6%) and EBITDA (by 15%). While we believe LVS’ revenues and EBITDA will fall this year, we expect they will recover to record highs in 2016 as the openings of the St. Regis Tower and the Sands Parisian add to the firm’s top line and profitability. Finally, we expect LVS free cash flow (FCF) yield to hit 7% by 2016 as capital expenditures decrease, and to rise to 8% by 2017. We apply the 14.3 historical EV/EBITDA multiple to get a stock price of $78 a share, or about a 40% rise from current levels over the next 12 to 18 months as GGR growth in Macau (and overall Asia) resumes later this year.
Disclosure: Neither I nor does my firm, CB Capital Partners hold any shares in LVS.
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