GXYYY - Macau Gaming Recovery Speeds Up But Key Stocks Still Undervalued

2023-08-02 13:16:37 ET

Summary

• Forecasters of the Macau recovery have consistently underestimated the speed and depth of revenue recovery ahead.
• The three U.S.-based Macau facing casino operators have moved higher, but still are not in a range which commands freshened valuations.
• Many investors continue to resist opening positions out of lack of conviction that recovery to 2019 levels can arrive sooner.

All amounts in USD.

The news out of Macau continues to show the remarkable resilience of casino gaming in the speed with which the market is recapturing the lost revenue during the covid crisis. As we have long pointed out, the underlying fundamentals that have driven revenue since Macau's earliest days in the 2000s would quickly reassert themselves as soon as China lifted its drastic zero covid travel bans.

Investors in the space had understandably run from the sector during covid as monthly revenues sank as close to zero as it was possible to recall. That draconian scenario stopped dead in its tracks on January 6th of this year when Beijing finally relented due to the massive damage the policy was inflicting on the general economy.

Our thesis at the time was built off catalysts not everyone agreed with. Many investors had become convinced that the Macau market challenges - even beyond the end of covid - were systemic. They cited the 2015 Beijing crackdowns on junkets, money laundering, and tech ID apps to identify gamblers to name a few. Furthermore, there was a persistent idea that, long term, China would exercise stringent regulation to stifle growth cycles and strangle profitability by influencing Macau officials to come down hard on license renewals. In fact, there was a contingent of some bulge analysts who actually believed there was a credible threat that the Chinese could confiscate casino properties owned by U.S. companies.

None of these fears materialized. While a ten-year license extension was granted to the current six concessionaires, it did contain somewhat of a tightened mandate for the operators to build non-gaming attractions. There was also a goal set to bring non-gaming tourist revenue to 30% of the gaming total. This is a non-starter, but heightened promotion of tourist visitation is already underway. The operators take the mandate seriously and while non-gaming revenue is now stable at around 10% of gaming, we do see it moving up over time enough to satisfy officials of real efforts.

Catalysts

• Meanwhile, recovery is proceeding at a speed few had predicted before the end of zero covid. Our take on the recovery cycle was that several under the radar catalysts would appear that were not, in our view, recognized by most analysts. Player behavior signaled positive notes. While we agreed that the VIP segment of the player base would continue to deteriorate due to the effective end of the broad-based junket programs, what was not immediately recognized was how quickly the far more resilient segment of premium mass play would grow.
• VIP players transformed from junket operators who were also the source of credit, to house serviced players who dealt directly with executive marketing people. This not only built the segment faster, but was more profitable when the commission costs fell. Pent up demand. This was far deeper and more sustainable than many observers believed. They agreed it was a factor, but likewise believed that it would run its course and tail off. This did not recognize how deep the bankroll savings had been held by players awaiting the end of the travel bans.
• The slump in the Chinese economy under the most challenging of declines in GDP would be far less than some feared. Gambling leisure demand is inelastic in the sense that pricing per se, i.e., costs of trips that are not comped, does not play a major role in decisions for trips. Plus, the attractions of special entertainment and sports events create an ongoing need to experience gambling s no matter the macroeconomic scene.

As a result of these factors and others, I have calculated a forward value range that reflects the knockout performance of the Macau recovery. Not only is it growing sequentially month after month, but it is clearly headed for a pace that will reach pre-covid 2019 baseline revenue before the end of this year.

Here's the current scorecard

Just three months ago, officials of Macau's DIC regulatory body were projecting that 2023 would see a US$17b recovery in total GGR (Gross Gaming Revenue). For context, the baseline pre-covid year of 2019 clocked $37.7b in revenue for the sector's six concessionaires. Then post January 6th, as travel bans fell, the market posted exponential gains each month for Jan-June.

DIC figures showed revenue was up a staggering 4,000% y/y distorted by comps with still covid impacted visitation numbers. But way above forecasts anyway. June's GGR number hit $1.89b, a slight, expected seasonal decline of around 2.2% But now we have July results which for the first time since the lifting of travel bans brought revenues to a most covid monthly 2023 high of just over $2b. That brought the seven-month total GGR to $12b up 263% YOY. That represented a recovery to 56% YTD against the comparable pre-covid year.

Both official and analysts scattered to revise their long-term forecasts for the year. Morgan Stanley upped their estimate to $20b for the year. It expects that the sector will reach total pre-covid revenues at a pace of $3b by October. Our own calculation based on our on the ground spotters at key peak as well as downtimes in the gaming week told a more bullish story. Average budgets and average bets post covid are trending high and surpassing 2019. We think going forward, monthly revenue will clock near or above $3b, which forms the basis for our higher call here.

Should 2023 meet our call of ~$26b, we further project that going into 4Q23 to 1Q24 the Macau gaming market will be tracking to exceed 2019 and in fact, establish a new high in the range of $34.6 to $39b.

Drivers

This year, sector leaders expect to open 3,732 additional rooms at properties advancing to completion of Phase Two and Phase 4 expansions that include non-gaming tourist attractions. The speedier recovery arc has also been driven in an expanded premium mass player segment. This vital part of overall revenue drivers is a product of migration of higher value player mix from declining VIP. Recovery overall is spearheaded by return of mass segments as well.

The big three moving to higher valuations in our opinion is evoking higher price targets earlier than believed

We have based our upgrade on the shares of the three parent companies with significant holdings in Macau and Asia, as I expect earnings spikes above current consensus.

The 52-week ranges indicated here have YOY comps reflecting the growth arc beginning from virtual zero to its current revenue recoveries as noted above. I have been bullish on the sector since the last quarters of 2022.

We move these stocks from BUY to STRONG BUY

Las Vegas Sands Corp. ( LVS )

Price at writing: $60.11.

52-week range: $24.96 to $61

Percentage of total revenue from Macau: 75% (Balance from Singapore). Both due for further expansion.

Consensus Price Target ("PT"): $0.69

Our PT factoring in our own catalysts: $75 to $77

Share of market post covid: Est: 23.4%

Revised earnings outlook 2023: $3.00

MGM Resorts International ( MGM )

Price at writing: $50.51.

52-week range: $9.20---$51.35.

Percentage of revenue from Macau: ~15 to 13%, could reach 14% as regulators have granted MGM increased tables for its two properties.

Consensus PT: $56.59.

Our target (revised up since last article) $68.

Revised earnings outlook 2023 : $2.95.

Share of market post covid estimate: 13%.

Revised earnings outlook: $3.00.

Wynn Resorts, Limited ( WYNN )

Price at writing: $109.06.

52-week range: $53.31---$117.86.

Consensus PT: $125.61.

Our target: Revised up to $155 to $160.

Share of market post covid: 16.7%.

Conclusion

Macau's recovery is moving at a faster pace than estimated by the majority of officials as well as bulge investors. Furthermore, the revisions to market-wide GGR upward combined with the expansion of room inventory plus higher value player mix commands our attention here.

All three companies noted here have solid balance sheets providing more than adequate cushions to take them through the last lap of the great revenue spurt in progress. Yet we believe due to lingering hesitancy of investors worried about macro issues as well as the sustainability of the current upside cycle, the shares remain at what we believe are bargain levels. Another factor here is operating margin improvements due to cost-cutting during covid that remain in place post covid.

We acknowledge that the chosen stocks noted here have all enjoyed significant upsides to date that have baked in Macau GGR revival. However, our calculations are based on both on the ground trends we see from our spotters, plus the now proven, unmistakable growing recovery in the out months. This will cast a new, bullish eye on the sector we believe has not as yet overcome investor conviction that the recovery is real. That points to the considerable run room ahead on valuations.

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