MLCO - Melco Resorts: Macau Casino Turnaround Is Just Getting Started

2023-03-06 22:40:39 ET

Summary

• Melco is set to capture pent-up travel and gambling demand at its Macau casinos as China moves past the pandemic disruptions.
• The company reported Q4 earnings, highlighted by positive comments from management suggesting strong trends into the current Q1.
• The launch of the new Cyprus, City of Dreams Mediterranean resort expected in Q2 can represent a new growth driver.
• We are bullish on MLCO stock.

Melco Resorts & Entertainment Limited ( MLCO ) is ready to move on from the pandemic disruptions that have pressured operations over the past 3 years. The company just released its latest quarterly results, and while the period was still impacted by various restrictions, the setup here is the ongoing reopening momentum expected to accelerate through 2023.

Since China moved to abandon the "Covid-Zero" policies in late December, all indications are that its casinos in Cotai, Macau are ready to capture pent-up demand for tourism and gambling. Even as shares of MLCO have more than doubled in recent months, we see room for more upside with the financial turnaround just getting started.

MCLO Q4 Earnings Recap

MCLO reported a Q4 GAAP net loss of -$0.57 earnings per American Depositary Shares (EPADS), while this figure was $0.26 ahead of the published consensus. Revenue of $337 million declined by 30% year-over-year and came in below estimates.

The context for these figures considers that the core Macau "City of Dreams" and "Studio City" resort destinations faced some setbacks going back to late Q3 that included a Covid wave in mainland China with strict quarantine efforts by the government at the time. These impacts were significant in reducing both gaming and non-gaming business dragging lower the firm-wide results in Q4.

In contrast, Melco's Cyprus and Manilla, Philippines resorts have been stronger, generating positive adjusted property level earnings, with improving operating metrics over the past year.

The firm-wide negative adjusted property EBITDA at -$6.8 million, narrowed from -$34.9 million. For all of 2022, Melco managed to essentially break even at the adjusted property EBITDA with a $1 million result, down from $235 million in 2021.

The observation from the chart below is that the Macau centers have been essentially underwater for the past three years during the pandemic. There was a small rebound in 2021 in terms of the casino "table drop" and "VIP revenues", but 2022 ended weaker as China tightened the Covid restrictions during much of the year, in contrast to the rest of the world.

Fast forward, the biggest development has been the apparent 180-flip in policy since mid-December when China abruptly moved to ease travel restrictions. For context, the latest reports suggest masks are no longer required in Macau.

By this measure, a path where Macau gaming recovers to pre-pandemic levels highlights the upside to earnings where the business previously generated more than $1.6 billion in annual adjusted EBITDA in late 2019.

This was a topic discussed during the latest conference call . Management noted that during the Chinese Lunar New Year holiday week in January into the current Q1, Macau adjusted earnings trended above 2019 pre-pandemic levels.

As a more generalized trend, the management observation is that on a comparable basis, the business is at about 70% of pre-pandemic levels which should climb through 2023. This backdrop supports the positive outlook for the year ahead.

The performance of our Macau properties in 2023 has been so far highly encouraging. During the peak days of Chinese New Year this year, we saw EBITDA reach 6 million a day and CO GGR exceeds what we recorded during Chinese New Year in 2019. Volume post Chinese New Year is holding up well and our daily average mass volume in February has been in line with January. This recent performance supports our continued belief in the return of pent-up demand and our view that Macau will continue to develop as a leading international destination for entertainment and leisure.

When looking at Melco, a key consideration is the company's balance sheet position, which has added significant debt in the last couple of years. The company ended 2022 with $2 billion in cash against $8.5 billion in gross debt for the consolidated group that includes the Studio City International Holdings Ltd ( MSC ) subsidiary.

Deleveraging going forward has been cited as a priority by management going forward with an understanding that the level is manageable assuming normalized operations. Favorably, there are no major maturities due until 2025 providing some time for the financial conditions to strengthen.

Is MLCO A Good Stock

We've been focusing on the Macau business turnaround as the most important development. At the same time, let's not forget about the diversified operation that includes the mega-resort in the Philippines and the operation in Cyprus. Melco is relatively unique among major casino stocks with this specific geographic exposure, including in high-growth markets.

On this point, a looming driver is the expected completion of the "City of Dreams Mediterranean", expected to be the largest integrated resort destination in Europe launching in Q2. Separately, there is also an ongoing expansion "Phase 2" of the Studio City resort in Macau adding 900 luxury hotel rooms along with non-gaming entertainment venues.

The efforts here provide a catalyst to ultimately surpass pre-pandemic benchmarks. If we consider that 2023 is a sort of transition year getting back to normal, 2024 and 2025 would get Melco finally back to firing on all cylinders.

According to consensus estimates, the forecast is for MLCO revenue to reach $3.4 billion this year, an increase of 149% from the 2022 result. Annual Revenue growth is expected to average above 26% for 2023 and 2025. The forecast we want to highlight is the outlook for EPS to rebound towards $0.58 in 2024 and nearly double to $1.12 in 2025, reversing a narrowing loss this year.

While MLCO does not appear in the chart below, we're placing its 1-year forward P/E of 24x in the context of other major "casino stocks". In this case, MLCO stacks up favorably, next to names like Ceasars Entertainment, Inc ( CZR ) at 25x, Wynn Resorts, Limited ( WYNN ) at 30x, and MGM Resorts International ( MGM ) from the same metric.

MLCO Stock Price Forecast

We rate MLCO as a buy with a price target for the year ahead at $17.50, representing a 30x multiple on the current consensus 2024 EPS of $0.58. The way we get there considers that the next few quarters should capture a meaningful improvement to the operating and financial trends at the core Macau casinos and resorts.

Historically, big-spending "VIPs" and international travelers are an important part of the bottom line for Melco, and we see these categories recovering through the second half of the year. Positive economic data out of China provides a runway for stronger-than-expected travel and gaming activity which should work to keep the bullish momentum toward the stock.

On the downside, the biggest risk would be some sign of a deteriorating macro environment. An unexpected slowdown in the Chinese economy, where the post-pandemic growth does not materialize, would limit activity at the Macau properties. Similarly, economic conditions in Europe will be key for the early success of the new City of Dreams Mediterranean project.

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