The worst call I’ve made of all time: Suggesting buying casino stocks as a safe play in August given their revenue structure, part 2:
Besides being Sin City and a theme park for all your vices, there is something else about Macau that has been bothering me intensively since I went for the Galaxy Macau opening ceremony in mid-May this year: it feels like a bubble. Walking around a casino and feeling like you’re shuffling around in Mong Kok is not really something that inspires feelings of “hidden value”, realizing that it’s impossible to get a room during a weekend* unless you book months in advance** makes you wonder if any of the bankers that flow in here from HK could be convinced not to bet on the house, and try holding a reservation anytime during a weekend for either dinner or playing Texas Hold’em – impossible! I guess a few of you are rolling your eyes, either saying “Of course it’s a bubble, it’s the world’s biggest gambling city by revenue!” or “Of course it feels like a bubble; that’s what makes you spend money and ensures it isn’t! Ever been to Vegas?” But walking through a lounge where the tables were full of people betting more money in single Baccarat hands than I’ve cumulatively spent over the last 4 years, or seeing massive nightclubs where it’s not dark because of all the champagne bottles with sparkler flares in them, is rather chilling, truth be told. Singapore opening up competition while there is an extreme expansion push in Macau again due to the better financial conditions after ’09 also does not inspire long term confidence.
* This is mostly due to junket operators which book up rooms in advance to cater for their Chinese tour groups and guests flowing in during the weekend. One can still snap up some great deals if you’re at the right place, at the right time, and just made a massive amount of money off the casino in question. I’ll discuss these shortly.
** Or get a prostitute. However, unlike before, if a sweet smile and “Hello Mr., what are you doing tonight? Massage?” isn’t enough to convince you, don’t expect them to try again anymore, the next fish is just around the corner. Also a bubble indicator; even the prostitutes get so much business that they can cut down on marketing.
Slowly, however, I am being more and more convinced that this is not a bubble, and this has more to do with the structure of Macau as a place, than of particular allures of the business models. First and foremost, Chinese citizens are not allowed to enter Macau more than 1 time every 3 months. This is unlikely to tighten further, and instead the proportion of the population that would be considering making a visit is growing, as are all aspects of the Chinese economy. Given that Macau casinos (unlike Vegas, or most other European/American casino cities) generates a spectacular +70% share of revenue from its high-stakes gaming and this effectively cements cash flow as these highly affluent people won’t be discouraged to spend their money anytime soon, don’t expect net revenue to fall. Other indicators of this spending trend are the results coming out of luxury brands in Asia, and the October Sotheby’s Auction in Hong Kong for traditional Chinese lots was thrilling to see.
Why putting your money on the house rather than the table is a good idea:
Furthermore, as the effects of Chindia’s growth helps lifting other areas in the region, a further influx of Korean, Taiwanese, south- and southeast-Asian gamblers is expected to increase as they too climb the income ladders and all these cultures hold considerably less stigma with gambling than western world peers. At the moment however, their currencies make it a rather painful expenditure to take on personally, so this source of income would marginally subtract from the overall picture until the financial markets recover. China however is a slightly different picture and slightly bigger, given the appreciation of the yuan to the HK$ (or US$) which is likely to quicken, and considerable assets held in cash since both property and stock look rather weak at the moment.
Given the long term picture that China is attempting to widen its growth rather than hightening it, the growth of an emerging middle class and Macau businesses’ desire to diversify themselves into an entertainment/event/conferences area, it appears as if prospects for Macau are good at the time being. Therefore, assuming that the Chinese economy doesn’t have an actual collapse, in terms of actually creating a real recession within the coming 4-5 years, the cash flow situation in the medium investment term looks solid.
For the slightly shorter term, there are relatively few new property developments undertaken and waiting to happen, and most of them tend to be hotel ventures rather than a significant new player in the casino space, indicating a lack of new and risky investments. Currently, Sands and MGM have publicly discussed the idea of expanding their business by opening new casinos around 2015-2016. Given the current cash flows that Sands enjoys from Venetian and Sands Casino, plus their recent Marina Bay casino that will boost their brand value if not necessarily their cash flow, I do not expect this to significantly impact the risk of the stock significantly. MGM is a slightly different player, but there have been hints at expanding in Asia and getting backing by their American parents for this, which would be a positive. As such, the sector risk for the big foreign players appears limited in terms of the worst case during a crisis.
Regarding the junket operators, they skew the economics of the signals somewhat by booking rooms far in advance to resell to their clients later, giving rooms the appearance to be booked in advance and resulting in the occasional amazing rebate given to casino players with timing and incredible wins. Prices go up on average, the casino can average out and the middle man takes a fat cut, everyone wins but the players that lose. Therefore, watching deal websites and checking just how far in advance the hotel itself reports rooms being full for is one of the best indicators of how the market at the moment is faring due to the Chinese payments. If you all of a sudden see more hotel rooms being made available on short notice, or that the average calendar day of booking for a weekend room stays the same across a few hotels, you can be certain that the China markeet isn’t providing the same inflows as it should for things to remain healthy.
The market dealt you 5 and 6, but you’re at the Blackjack table, double down?
This requires some speculation which is at least better than making the decision off the suits. Lets look deeper into the specific companies.
Sands China Ltd. has a turnover of roughly HK$32.3 bn off their two rather mature major properties, Sands and Venetian, with a net profit margin of 16.1%. P/E ~31 and P/S of roughly 5, and Current/Quick ratios at around 1.07. It’s balance sheet looks rather “fine” for a casino company, and again reaffirms the idea that it is a rather stable company with big reserves matched by equity, and a fairly good ratio of current liabilities to total debt. Current and quick ratios are nothing spectacular either way in Macau given the assets picture, although it would make a European investor shaky.
MGM China Holdings Ltd. is less interesting and less traded, so I’d just keep out, with across-the-board worse numbers than Sands, save for P ratios, which are not really reliable given their recent IPO. (This comes in at comparative 1/3 of the turnover, HK$12.1 bn, to boot.)
Wynn Macau, Ltd. is looking better with 2010’s 50% uptick in turnover to HK$22.4 bn, 24 P/E, 4.8 P/S (19.7% profit margin) and C/Qr’s at a few percent short of 1. The problem here would be the rather huge long-term debt picture, which is impressive considering that they could perhaps have the “average most mature” property portfolio with their one casino and few expansion plans, and puts the C/Qr’s in a new and troubling light. Compared to Sands, you’re taking a leveraged bet here as an equity investor, but you also get some extra bang for your buck both in valuations and financial health, but rallies could also be more muted.
Galaxy Entertainment Group Ltd. is much more interesting, since it shows a mixed bag for 2010. After the August/September fall, P/E is currently at 54, meaning it was near the 100’s at its best! Turnover was strong at HK$19.1 bn (off their one property in Star World which is always full of rich mainlanders) but resulted in an abysmal profit margin of 4.66%. It has a P/S of 2.56 at the moment! This is not particularly sane given the Macau growth coupled to the China growth story, and looking at GEG’s C/Qr’s they’re both below 70% which is somewhat disturbing given their relatively lower reserves-to-current liabilities. The big story here that doesn’t show up in these figures is of course the opening of the massive 450-table, 2 200 room Galaxy Macau casino out of which GEG owns 50% of the rooms and rents the rest out to Banyan Tree and Hotel Okura for a pound of flesh. The margins off these rooms are also significantly higher (Starworld is among the cheaper places to get sleep if you can get a room, Galaxy is high value, but much less friendly to your “golden bulls”) and in total Galaxy Macau adds at least nearly 120% of tables tables and slot machines, and 200% directly owned hotel rooms, plus extra rents for the other hotel franchises, to GEG.
The profits for GEG as a whole seems squeezed given the costs of holding the building activities going for the extra 2 years it took, and will be a little bit suppressed given the discounts they have given on their hotel rooms. In contrast, Star World Casino was a display in how to attract ever gambling affluent people, so despite the slightly more anonymous positioning and decor they have always managed to keep the turnover high. Accounting for a late open on the pure revenue figures for the year, one would estimate maybe casino market share for GEG to go up by about 50% (using the tables for reference, discounting 25% because of established player bases elsewhere and accounting for late opening which is a further 38% discount, then 10% more for further hotel discounts), and then multiply that with the market growth. Assuming market growth is, in the worst case, 20% YOY at the end of the year, that would give a turnover boost for this year by 80% for GEG, trading it currently at estimated 2011 P/S of 1.42, when daily sales at year end are likely to have shot up by a factor of 2.5 plus extra rent from their restaurants, shopping outlets and hotels. If we just benchmark it towards Sands which would have a similar portfolio of properties (Sands + Venetian, which match Star World + Galaxy respectively) and assume that the extra tables for GEG are roughly offset by the extra property for Sands, we get a turnover boost of 55%, without accounting for the turnover/table ratio of Star World which is likely to carry over to Galaxy.
Assuming profit margin would fall in line with other casino operators and average about 12% after discounting Melco and allowing the rest to offset SJM, this would mean a profit jump on these calculations to HK$3.1 bn for 2011, and around HK$7.5 bn for 2012 with average 15% annual market growth and removing all the discounts measured above. GEG would then trade at 15.7 P/E for 2011! Slight offsets are still due for the late opening of Galaxy on the cost side, but 20 P/E without considering 15% annual revenue growth is a great opportunity to enter!
SJM Holdings Ltd. is a real interesting stock to watch as well. It as massive turnover at HK$57.2 bn, with profit margin of a measly 6.22%, P/E of 18.8 and thereby P/S of 1.17! Its total debt/equity is at 35% and this complements the 1.5 C/Qr’s and makes it more financially sound than a lot of its competitors. The disparate portfolio of essentially all the smaller casinos around Macau is a profit margin negative in that they don’t tend to get a relative influx of high stakes gamblers to the same extent as its competitors, but huge turnover growth in 2010 (68%) off the back of generally returning gamblers more than makes up for this since it is likely to have carried over into 2011. Also, their various hotels are fully booked almost all the time, and they have +HK$10 bn in cash even after their dividend payout ratios of 50%. Wynn gives nearly 90%, but everyone else is null or negative here, and the only one that comes close in cash on hand is Sands! SJM probably has less room than GEG to boost profit margins given their structure and affiliated costs, but assuming a 10% profit margin in good times does not seem outlandish, and 8% in bad times neither. If P/E would be at the 22-28 range, and profit margin would be at 8%, then the share price could be at HK$34.4 for the middle P/E range in 2011! Not going to happen, but it shows some of the potential of this company when we are trading so low at the moment. This seems to be the “safe” bet, and still it is far below its yearly SMA at 14.6.
Given the substantial losses of Melco International Development Ltd. I have chosen not to analyse it. The ratios are too far out of the water and the market doesn’t really seem to care, and if you’re asking to do this, you better look at technical analysis or shorting. Suffice to say, if you’re playing this one, you’re not in the casino to play Baccarat or Blackjack, but Caribbean Stud! Horrible odds, but ooohh! so sweet a potential payout!
Dealer shows an Ace, and asks for your action now, what to do?
Playing anything like Sands or Wynn is most akin to just checking and asking for the next card. Not very interesting, not very rewarding. Sands made a 30% run in the last three days, and is trading between its yearly and three-quarterly daily SMA’s. It’s more “playable” in terms of warrants than the rest, but still, given the fundamental structure and valuation, this is not where I see the most potential value, especially when price firmly turned at the monthly daily SMA this Friday.
SJM provides better value, and hasn’t quite caught up with its MA’s in the same fashion, and was trading much more firmly off them on the way down here. We are seeing a year quarter/half bearish cross on the daily SMA’s, but that is not too much to worry about as that is very far from current price at 17. Given the better valuations, good margins for provit margin catch-up and massive turnover, this play is like asking for insurance. Not very sexy, perhaps not even smart, but it removes a lot of your risks while you’re still essentially gambling on the whims of unpredictability.
MGM is again not considered due to lack of data, and because of the poor shape of profits, Melco is in the same pool. Playing either is a little bit like throwing in your hand now and placing your money at the “Any Pairs” bet for the next hand. Melco’s extremely big cash reserves compared to liabilities, and assets compared to liabilities as well, would be a good play, but these markets are unlikely to discriminate too carefully.
Galaxy is, to continue the analogy, the doubling down option. Good fundamentals, massive previous outflows and leaving you with the option of magnifying whatever results the market throws at your hand. MACD 21/63/21 Day shows a turning point, there has been a smaller volatility-adjusted rally compared to its peers and there’s still been a 42% bounce off its intraday low on Tuesday! The next really cool thing is that it did not show hesitation near the yearly SMA, which is bullish and that on top of a volume run. Warrants are also coming into play from being waaay out of the money, so this could be your big chance at taking back extremely good returns.
Some final words of warning:
These markets are choppy, and more bad news out of Europe could, in the short term, be really bad and again throw fundamentals out the window, same thing if this coincides with worries stemming from the US budget debates or presidential election run-ups. However, the upshot is that this is likely temporary, since China is likely to throw more stimulus at its economy or at least hinder the tightening cycle should things get worse, which could be an unabated good for Macau casino stocks. Furthermore, the golden week open will be interesting to watch, and the correlation between casinos and China equity markets is where I will keep my nose pointed. Short term things could be bumpy, but there are few stocks I like more than these! Keep an eye on the junket operators, and the second rooms start to get snapped up, think carefully about whether or not you want to be in here. Likewise if the room bookings drop.