2023-09-25 17:25:06 ET
Summary
- Melco has quite a lot of debt and will likely need to do some refinancing.
- They have some credit facilities and a cash balance to draw from, and they are operating cash profitable again now.
- Still, they have not seen a full Macau recovery.
- These sorts of debt situations shouldn't be taken lightly. We also think that the net income will be hurt after maturities in 2025 given the rate situation globally.
- Some cost control can be permanent, and will help them recover to a more sustainable position if the topline recovers, but there are still many uncertainties in the Melco story.
Melco Resorts & Entertainment ( MLCO ) is an interesting company which has been expanding their portfolio of attractive casino and leisure real estate over the last couple of years, during the COVID-19 depression in gaming. Some of the cost reductions achieved during COVID-19 are going to be permanent, and the beginning of a recovery even in Macau means that the future could be quite bright for the company. But there is an important issue, and that's the debt which is really hamstringing the company and will eventually lead to higher interest costs or worse.
Q2 Breakdown
Let's begin with some of the positives, which is that cost control moves are coming into effect and there was some one-off bloat in this quarter's costs. About 25% was being detracted from Macau EBITDA due to some residency concerts, with per day OPEX being about 10% lower in a more normalised moment. Macau is more than half of the EBITDA.
Moreover, the company maintains that there are cost control measures that should bring down costs in the theoretical, even that results return to pre-COVID levels. Therefore, pre-COVID revenues would result in beyond pre-COVID EBITDA. That should translate to about 200 bps in margin improvement.
However, Macau is not back to pre-COVID levels yet , it is still about 57% of 2019 levels. It wasn't helpful that there were also typhoon related closures after the close of the quarter.
It is important it gets back there, because there is a debt situation to be worried about.
The cash position does not cover the debt obligations coming due in 2025. While there will be some cash generation, even assuming that EBITDA and cash flows restore to 2019 level, the net debt to EBITDA is still at around 4.5x, which is high. EBITDA is not very likely to come entirely back to 2019 levels in the immediate future. While COVID isn't the issue as much anymore, Macau revenues and Melco revenues in Macau in general are connected to non-gambling activities as well, and do rely on convention revenues and other markers related to the level of business activity in China.
Bottom Line
We are not sure what sort of cash arrangements Melco will arrange, and note that the assets are almost completely covered by leverage. They have some credit facilities that can still be drawn down but it's not entirely enough with the cash to cover 2025 maturities. But at the very least investors should be concerned about the evolution of interest costs. While the company is back to being EBITDA profitable, the need to refinance the debt in some way will reset rates at higher levels. Their financing in the past has been HKD denominated, and HK rates have gone up meaningfully along with the rest of the world . The more dire debt situation will likely also mean incremental financing will come with higher risk premiums. Current interest expenses are between 5-6%, and we think that the next round of debt financings will come at twice that rate.
They may generate some $100s millions in cash before the time comes to meet maturities, but they also have CAPEX that they need to do. Things are tight, interest costs are likely going to rocket higher starting in 2025.
We think the risk-reward in Melco is not attractive at the moment as we still need to see a full recovery in activity. Interest costs will likely erase shareholder profits even if we're back at pre-COVID levels after possible refinancing unless the cost control measures slated to be permanent indeed have their effects. A tight debt situation should not be taken too lightly.
For further details see:
Melco's Debt Is A Bit Concerning