Volume I, Issue 16 (released on July 31, 2014)
Hello all! I hope you all are having a great summer. I just got back from a very nice extended weekend vacation with my family in Martha’s Vineyard, and I will be going on vacation again from August 1st through August 9th.
This Issue is almost entirely dedicated to an article I wrote on Las Vegas Sands Corporation (NYSE: LVS). Yes, it’s finally done! The article is written in almost the exact same format in which it will be submitted to Seeking Alpha. I am sending the article out to all of you at least a day earlier than it will be submitted to Seeking Alpha, because I want there to be some benefits to being signed up to receive my Newsletter. I decided not to submit the article to Seeking Alpha as a “Premium Article,” which means I won’t get paid for writing it, because submitting it as a Premium Article would prevent me from uploading it to my website. In the future, I want to write at least one Premium Article for Seeking Alpha (one “Pro” Premium Article). However, I am not sure yet what stock I will write about.
Before I get into the article, I will do a quick Portfolio Update (7/14/14 – 7/25/14) just to keep you all up to date on the changes my portfolio is undergoing.
As a reminder, this Issue is available on my website! If you have any questions about anything that was written in the article, please feel free to email me. Thank you!
Portfolio Update (7/14/14 – 7/25/14):
Over the past two weeks my portfolio underperformed the S&P 500 significantly, with my portfolio’s value declining by 0.39% and the S&P 500 rising by 0.55%. My biggest positions did fairly well over the two week period, but my portfolio’s performance was affected by the very bad performance of the worst performing stocks in my portfolio over the last two weeks. This demonstrates yet again how only a few stocks can throw off the collective performance of an entire portfolio. The question is: Am I worried about my portfolio’s performance beginning to underperform the market? No, absolutely not. Over the past few weeks, I’ve begun altering my allocation to each stock in my portfolio, by taking profits (selling shares) in some of my best performing stocks and buying more shares of the defensive stocks in my portfolio. This is a necessary step to take, because (as mentioned in Issue 12 of my Newsletter) I believe that the S&P 500 will experience a 10-15% correction beginning in the next month or so. Therefore, I am repositioning my portfolio’s allocation and moving more money into “defensive” or “alternative” stocks/sectors. I am willing to accept short-term underperformance if it means I will outperform the S&P 500 in the long-term.
Below is some information on simulated portfolio, and a list of my five best and worst performers for the past two weeks:
- My portfolio’s starting balance (on 1/1/2014): $1,000,000.00
- My portfolio’s current balance (on 7/25/2014): $1,075,624.48
- My portfolio’s return to date: 7.56%
- The S&P 500’s return to date: 7.03%
- Number Of Currently Profitable Positions: 23
- Number Of Currently Unprofitable Positions: 9
- Percentage Of Positions That Are Profitable: 71.88%
More measures of risk-adjusted performance will be added shortly!
My Five Best Performers For Past Three Weeks:
- Companhia Vale do Rio Doce (VALE): +5.05%
- Bed Bath & Beyond, Inc. (BBBY): +4.86%
- Abbott Laboratories (ABT): +4.21%
- CVS/Caremark Corp. (CVS): +2.89%
- Amgen Inc (AMGN): +2.56%
My Five Worst Performers For Past Three Weeks:
- Life Time Fitness, Inc. (LTM): -15.54% (<= I sold most of my position weeks ago)
- Michael Kors Holdings, Ltd. (KORS): -8.64% (<= I sold most of my position weeks ago)
- Zynga Inc. (ZNGA): -7.41% (<= second smallest position in my portfolio
- IAMGOLD Corp. (IAG): -7.16% (<= fourth smallest position in my portfolio)
- T-Mobile US, Inc. (TMUS): -6.90%
I will probably re-add shares to the positions that I sold shares from at some point in the future.
Life Time Fitness (LTM) sold off significantly because it reported earnings that missed analysts’ consensus estimates. Due to the extremely cyclical nature of the stock, I took profits in my position by selling shares of the company over the past few months while LTM was near its recent high. The position moved under water (unrealized loss) for the first time in the last 5-6 months. LTM is currently trading at its lowest Price/Earnings (P/E) multiple, Price/Book (P/B) multiple, Price/Sales (P/S) multiple, and Price/Free Cash Flow (P/FCF) multiple since 2009. Therefore, I will probably be buying more shares of the company soon, because I think that the company is currently trading at a significant discount to its long-term historic multiple averages.
I will likewise be adding to my position in BBBY and WFM, ideally after both companies’ stock prices dip a bit, because I believe that both of those stocks are also currently trading at a significant discount. My decision-making is clouded somewhat by my bearish view on the market, so I have not decided yet whether or not to buy now or wait to see if those three stocks follow the market lower (if the S&P 500 begins to experience a correction as I predict it will). I will update you all on the situation in future Issues of my Newsletter.
Now on to my article on LVS... The article is written in Seeking Alpha format and it can be found below:
Title: Las Vegas Sands: The “Best Bet” in the Growing Casinos Industry
Point #1: The Resorts & Casinos industry is in an accelerated growth cycle, led by Macau. Las Vegas Sands (LVS) dominates the industry and is best positioned to benefit from this continued growth.
Point #2: Potential Japanese legalization of casinos offers a new and significant casino market with major growth potential, and LVS is well-positioned to take advantage.
Point #3: LVS outperforms its competitors through its “convention-based integrated resort business model" and its focus on the mass market, generating consistently high earnings growth and high margins.
Point #4: LVS currently trades at a discount to its long-term average valuation multiples, and its current share price offers an excellent long-term entry point.
“The house always wins” – and Las Vegas Sands Corporation (NYSE: LVS) is the biggest winner out there. LVS is a multinational integrated resort operator that dominates casino markets around the world, with a 51.59% market share of the total gaming revenue in Singapore and a 22.0 percent share of gross gaming revenue in Macau (alternating as #1 and #2 in share in different months).
The Resorts & Casinos industry has benefited significantly from an improving global economy, and it is a high growth industry with huge upward momentum. Bloomberg’s 2013 “Industry Leaderboard,” an analysis of 55 industries and 600 leading companies, ranked the casinos industry as the sixth fastest-growing industry (ranked based on sales/revenue growth). Will this huge growth continue? Yes, and there are two reasons why: Macau’s expansion and the potential legalization of casinos in Japan.
Macao’s Expansion And Growth Potential
Asia’s growth in recent years, particularly in China, has created a sizeable middle class. This new generation of gamblers drives the future growth of the Resorts & Casinos industry in Macau.
Macau is the only part of China where casino gambling is legal, and the Chinese government recognizes the potential, investing significantly in infrastructure throughout the entire Pearl River Delta region (which includes Macau). LVS’ 1Q14 Earnings Call Presentation outlines seven specific infrastructure improvements in the region:
Source: Las Vegas Sands 2Q14 Earnings Call Presentation (Investor Relations)
Note in particular Hong Kong-Macao-Zhuhai Bridge and Hengqin Island. The Bridge, expected to be completed in 2016 (see above), will allow people to travel from Hong Kong to Macau by car for the first time, cutting down travel time and allowing passage directly from Hong Kong’s international airport to Macau. In short, this investment will significantly increase the tourists visiting Macau, and LVS’ revenues there. The Hengqin Island projects include Chimelong Theme Park (opened January 2014), which is ultimately expected to attract 20M visitors annually. These projects have received $20 billion of investment already, offering LVS opportunities for increased resorts.
There is more. China is building the world’s most extensive high speed rail network, giving ease of access to Macau for millions of people throughout southeast China. Many of those people are new members of China’s middle class, and (as yet) most have never been to Macau. However, many will want to visit resorts as nice as LVS’ Venetian Macao.
In short, China is making significant investments in regional infrastructure that support its casino industry – a long-term development receiving little US business news coverage.
LVS Is Capitalizing on Macau’s Growth Potential
Las Vegas Sands recognizes these trends in China and has incorporated those trends into its business model. In Las Vegas Sands’ Q2 2014 Earnings Call Presentation, the company lists five key trends:
Source: Las Vegas Sands 2Q14 Earnings Call Presentation (Investor Relations)
To take advantage of these trends, LVS also focuses less on “VIP gaming” and more on mass tables, setting it apart from its competitors:
This “mass tables” focus drives significant bottom line growth, relative to industry averages, and allows LVS to achieve the highest operating margin in the industry (see below).
Japan Will Be The “Next Big Thing” For The Casino Industry
Japan presents the next frontier after Macau. Japan’s parliament began debating a bill to legalize gambling in mid-June, and prospects of passage are strong. The Wall Street Journal describes this as a major growth play by the government for the Japanese economy. How big could this market be?
Legalizing gambling is designed to bolster momentum for a tourism industry that’s already an increasing source of growth for Japan. The brokerage firm CLSA estimates that Japan could generate $40 billion/year in gambling revenue, assuming integrated resorts in Tokyo and Osaka and 10 smaller sites elsewhere. If so, the market would become the second largest in the world behind Macau, out of an estimated total revenue (annualized) of $90.55 billion (2014: Bloomberg). Competition for casino licenses in Japan is sure to be fierce, and MGM Resorts International (NYSE: MGM), Wynn Resorts Ltd (Nasdaq GS: WYNN), Melcro Crown (Nasdaq GM: MPEL), and LVS have all announced plans to bid. LVS, however, is best positioned to win (see below).
The question is not whether lawmakers will legalize casinos, but whether they will do so before it is too late to “rake in the chips” (so to speak). On September 07, 2013, the International Olympic Committee (IOC) selected Tokyo to host the 2020 Olympic and Paralympic Games instead of Istanbul and Madrid. This market is poised to reward early entrants.
LVS stands in by far the best position of any U.S. casino operator to build an integrated resort in Japan. One of the two casinos Japan’s Prime Minister Abe visited in Singapore was the Marina Bay Sands, owned by Las Vegas Sands. The Marina Bay Sands is the dominant resort in Singapore’s casino market (comprised of only two casinos!), and in 2013 it collected $3.135 billion of the $6.077 billion total revenue in that market – a 51.59% market share that will only increase with Marina Bay Sands seeing a 6.6 percent increase in gaming revenue over 2012, compared to 1 percent for Resorts World Sentosa, its principle competitor. Prime Minister Abe had the Marina Bay Sands in mind when he admired the success of integrated resorts in Singapore.
The debate over the bill is by no means over; in fact it is still in its beginning stages, and the debate “…will be taken up again when the Diet resumes in autumn.” Many Japanese lawmakers believe that the bill will pass in the autumn session of parliament. For example, Komeito party lawmaker Masakazu Hamachi, “who serves on the cabinet committee, said in a May interview…that once debate began, the bill had a good chance of passage in the [autumn] session, which is likely to start in September or October.” One thing is for certain- the more time that goes by, the more pressure Japanese lawmakers will face to pass the casino legalization bill quickly before it is too late. The bill to legalize casinos isn’t even the only one that lawmakers will need to pass, because when that first bill is passed “a subsequent bill detailing the rules of casino operation would also need to be approved,” and that will take even more time and effort.
It will take five years or more after legalization and competitive bidding before the first casino is operational. With the opening ceremony for the 2020 Summer Olympics almost exactly six years away, lawmakers will need to come to a decision quickly or Japan won’t be able to receive the full economic benefits expected from the effort. Prime Minister Abe knows this, and because gambling is the third arrow of “Abenomics,” legalization appears likely. Thus, the autumn session of Japan’s Diet (September-October) will prove a catalyst boosting LVS’ stock price.
LVS is Best Positioned to Exploit Japan’s Potential Casino Market
If Japan legalizes gambling, LVS will succeed over its competitors for three reasons:
Reason #1: LVS has “deeper pockets” than its rivals, and is prepared to build an integrated resort in Japan. On February 24, 2014, CEO Sheldon Adelson said LVS will spend “whatever it takes” on a casino project in Japan. The New York Times article quotes Mr. Adelson as saying “would I put in $10 billion? Yes.” This is more than anything a competitor could offer, approximately double what Melcro Crown plans to spend. LVS’s market cap ($58.8 bil as of July 28th) is approximately 2.75x the market cap of WYNN ($21.4B as of July 28th), LVS’s closest major U.S. competitor. To put it in a another perspective, LVS’s twelve-trailing-month (TTM) free cash flow was $3.69 billion for the twelve month period ended on Q1 2014. In comparison, MGM, WYNN, and MPEL had TTM free cash flow of $749 million, $839 million, and $992 million respectively for the same period.
- Note: I only looked at data up until Q1 2014 because LVS is the only one of those four companies that has released a Q2 2014 earnings report so far.
Outspending competitors will enable LVS to win the best locations, attract more visitors, and gain a bigger share of the “pie.”
Reason #2: LVS’ management team has an extraordinary track record of successfully expanding into, and dominating, foreign casino markets. LVS’ self-described “convention-based Integrated Resort business model” works exceptionally well in countries with a growing middle class, and the company’s focus on the mass segment of its business allows the company (and shareholders) to see a consistently high return on invested capital (ROIC). In fact, one of Las Vegas Sand’s “development opportunity parameters” is that the company will receive a “minimum of 20% return on total invested capital” for every new operation that the company begins. On a company level, LVS’ has seen its ROIC march steadily higher year-over-year until it reached 14.75% at the end of 2013, significantly outpacing the ROIC of its competitors (see below). The Marina Bay Sands and The Venetian Macao are just two properties demonstrating the management team’s ability to execute the company’s business model in an effective and extremely profitable way.
Reason #3: The company’s “convention-based Integrated Resort business model” drives the highest profit margins through its mass market segment:
Source: Las Vegas Sands 2Q14 Earnings Call Presentation (Investor Relations)
As you can see from the chart above, LVS gained a 33% market share of EBITDA in TTM 1Q14.
Why LVS Is The Best Company In The Industry:
In an industry where every new “project” requires over $1 billion, one reason why Las Vegas Sands is the best company in the industry is that it has access to more cash than any of its major competitors. In todays ever more globalized world, it is extremely important for casino companies to have large cash reserves because you never know when the next great opportunity for growth will spring up. Las Vegas Sands has access to enough capital to fund new projects in multiple different countries.
In the Las Vegas Sands’ 2Q14 Earnings Call Presentation, the company highlighted four “Promising Areas of Future Development…” Those areas were “Macao, Japan, South Korea, and Vietnam.” I have already talked about how Las Vegas Sands is in the best position to expand into Japan, in the event that casinos are legalized there, but what about the other three “areas”?
Ongoing Developments/Improvements In Macau: Las Vegas Sands is currently managing four operations in Macau; “The Venetian Macao, Sands Cotai Central, Four Seasons Macao, [and] Sands Macao.” However, LVS ISN’T DONE YET. The company’s management team clearly thinks that there is still some room to expand operations in Macau, and the company currently has two new projects in the works (both of which are expected to open in 2015). Those two projects are The Parisian Macao and “…a fourth hotel and mixed-use tower, located [at the Sands Cotai Central], under the St. Regis brand.
The Parisian Macao: An integrated resort that will be the company’s fourth property on the Cotai Strip. The Parisian Macao is “…expected to open in late 2015…It is to feature approximately 3,000 rooms and suites, gaming space, a retail mall, replica Eiffel Tower, MICE space, diverse food and beverage options, and entertainment. The total cost of the project is an estimated US$2.7 billion.” Las Vegas Sands Corporation’s 2Q14 Earnings Call Presentation indicated that The Parisian Macao is expected to have approximately “450 table games and 2,500 slots and ETGs.” Las Vegas Sands expects to pay approximately $680 million on the project in 2014, and the company had “…capitalized costs of $464.8 million, including the land premium (net of amortization) and $44.1 million in outstanding construction payables, as of March 31, 2014” (From Q1 2014 10-Q filing).
St. Regis Tower at Sands Cotai Central: This “…mixed-use tower…will feature approximately 350,000 square feet of gaming space, approximately 800,000 square feet of retail, dining and entertainment space, over 550,000 square feet of meeting facilities and a multipurpose theater” (From Q1 2014 10-Q filing). The company expects to pay approximately $700 million (paid off over the next four years) to complete the project, which is expected “…to open in early 2015.”
Just one of those projects alone would provide a huge boost to the company’s top and bottom line, but both of those projects coming online in the next year (approximately) provides huge growth potential for LVS in Macau. As anyone who follows the Resorts & Casinos industry will tell you, having a lot of hotel rooms available is a huge deal for casino operators because more guests staying in your hotel rooms equals more guests gambling at your tables. It just so happens that Las Vegas Sands has by far the most hotel rooms in Macau. The company currently has 9,277 hotel rooms and “…operates 38% of Macau’s current 4/5 star hotel inventory” (From Las Vegas Sands 2Q14 Earnings Call Presentation). That number is expected to grow significantly over the next four years. Just to provide a quick example, if The Parisian Macao and the St. Regis Tower open on time, as I’m sure they will, Las Vegas Sands expects to have 2.72x the amount of hotel rooms in Macau that its next closest competitor (Galaxy Entertainment) has by December 31, 2014. This can be seen in the picture below:
Source: Las Vegas Sands 2Q14 Earnings Call Presentation (Investor Relations)
Information from the 2Q14 Earnings Call Presentation indicates that Las Vegas Sands had an average “Mass Table Win per Table per Day” over the last four quarters of $12,069.25, an average “Slot and ETG Win per Unit per Day” over the last four quarters of $367.25, an average Premium Mass “Win per Table per Day” for the latest quarter of $20,751, an average “Rolling Win per Table per Day” over the last four quarters of $33,734.25, and an average $32,568 “win per VIP per day.” That should give you an indication of how much Gross Gaming Revenue (GGR) those two new properties will be able to generate for Las Vegas Sands once they open.
Summary: Whether it’s Japan, South Korea, or Vietnam, I believe that LVS is in the best position to capitalize on all future growth opportunities in the Resorts & Casinos industry.
LVS has more cash on its balance sheet than any of its major US competitors, and the company is also more financially solvent. Below is a chart comparing LVS’s financials to those of the company’s major competitors (only competitors that trade on US stock exchanges).
- Notes: MorningStar does not have Free Cash Flow data for each quarter for MPEL, so I just added the full year 2013 Free Cash Flow Growth rate (full year 2013 vs. full year 2012). All of the above data only goes through Q1 2014, because LVS is the only casino company that has reported Q2 2014 earnings so far.
Notably, LVS’ Free Cash Flow (operating cash flow minus capital expenditures) likewise is higher than its competitors, providing it with the means to finance future growth opportunities. Its Free Cash Flow and cash (and cash equivalents) on its balance sheet give LVS a distinct advantage.
Additionally, LVS is currently trading at a lower Price/FCF multiple than any of its competitors except for MGM. Although that might make MGM look cheaper, you should take into consideration two things: how fast are both companies growing their FCF, and how much leverage do they both have? From the chart above, one can clearly see that LVS is growing its FCF at a much faster pace than MGM. In terms of leverage, MGM’s 10-Q filing for Q1 2014 showed that the company had $12,930,728,000 in long-term debt as of March 31, 2014, while LVS had only $9,968,879,000 at the same point. Thus MGM held roughly $3 billion more in long-term debt than LVS even though LVS’s market cap was approximately 4.7x larger than MGM’s (as of March 31, 2014).
MGM has also not posted a positive Net Income amount since 2011, and the company has only had one year with positive Net Income in the last six years. As far as Debt/Equity ratios go, Wynn Resorts Ltd and Caesars Entertainment Corp actually have negative equity values (more liabilities than assets) so their Debt/Equity values could not be accurately calculated. MGM has a much higher Debt/Equity ratio than LVS, which is another indication that MGM currently is significantly leveraged.
Another indication that LVS is financially healthy is the fact its Quick Ratio and its Current Ratio (current assets over current liabilities) are both greater than 1. While some of LVS’s competitors have higher Quick Ratio and Current Ratio values than LVS does, most of those companies also have a lot of debt on their balance sheets that they wont have as easy a time paying off as LVS will. Additionally, those companies’ Quick and Current ratios fluctuate year by year much more than LVS’s.
Being financially healthy is the deciding factor between success and failure in the Resorts & Casinos industry, as investors in Caesars Entertainment Corp (CZR) will tell you. Casino operators that are financially healthy see their share prices outperform those of less healthy peers in the long term because investors are generally happier with companies that are able to effectively use debt, rather than equity, to finance operations. This is another area in which LVS excels, because (as LVS stated in its Q2 2014 earnings call presentation) one of its “development opportunity parameters” is “25% ‐ 35% of total project costs to be funded with equity (project financing to fund 65% ‐ 75% of total project costs).” This is good compared to LVS’s competitors, especially when considering how all these casino operators plan on expanding into Japan- both Wynn and MGM have already announced that they “intend to conduct initial public offerings for planned Japan resort ventures.”
LVS’s ability to do this has made investors very happy, and it results in significant outperformance in the long term. This long term outperformance can be seen below, which shows the stock price performance of five casino operators (and the S&P 500) over the past five years:
Source: Yahoo Finance (interactive charts)
The above long-term time frame shows how great stocks significantly diverge from “the pack” and show their true colors. And this chart ranks the casino stocks exactly how I would rank them: LVS, MPEL, then WYNN, then MGM, and finally CZR.
LVS and MPEL, the two healthiest casino operators, significantly outperformed the stock prices of their peers over the last five years, with LVS leading the way and demonstrating resilience during the current correction. That is exactly what every investor wants to see: strong outperformance on the upside and outperformance on the downside.
There were many factors that led to this result. Financial strength enabled LVS to gain significant shares of total Gross Gaming Revenue (GGR), enabling LVS to build open and maintain four (soon to be five) operations in Macau, and a huge operation in Singapore (Marina Bay Sands).
LVS is committed to Maximizing Shareholder Returns
Free cash flow enhances shareholder value by paying off debt by providing a dividend or increasing a current dividend, or by expanding operations. LVS’ free cash flow currently is growing at an extremely fast rate (+117.22% in 2013), and LVS has committed to using this cash to maximize “return of capital through recurring dividend and stock repurchase programs” (from the company’s Q2 2014 Earnings Call Presentation). LVS has returned “nearly $8.3 billion of capital to shareholders over the last 10 quarter,” as the company’s Q2 2014 Earnings Call Presentation reflects:
Source: Las Vegas Sands 2Q14 Earnings Call Presentation (Investor Relations)
I like best the sentence that reads “…recurring quarterly dividend program with a commitment to grow the recurring dividend by at least 10% annually.” That is really quite amazing and, as one can see from the data above, the company appears to be following through with its commitment.
More Data For Las Vegas Sands vs. Competitors
LVS growing its revenue and EBITDA faster than almost all of its major competitors, it also has fantastic margins, a superior dividend yield, and it is trading at a great valuation relative to its peers.
- Notes: All of the above data only goes through Q1 2014, because only two casino companies have reported Q2 2014 earnings so far. The y/y growth figures are for Q1 2014 compared to Q1 2013.
This data, and the data from the prior table, demonstrates that LVS presents the best financial picture for investors of any company in the industry. The data also shows that LVS is growing extremely fast, is financially healthy, and is generating enough cash to fund any endeavor that the company’s astounding management team decides to focus on. In short, LVS is currently in a phenomenal position as a company to capitalize on future growth opportunities. I believe that Las Vegas Sands has set itself up to outperform its competitors over the next five years, similarly to how the company outperformed its competitors over the last five years.
The Risks Inherent In Any Casino Stock:
I would be remiss if I did not mention (and address) the risks associated with casino stocks. These are not necessarily the risks found on a standard 10-Q or 10-K filing, which because those are readily available to investors. Instead, I focus on three risks that would be of concern to any investor who follows news reports on specific casino stocks or the industry in general. Many of the following risks are specific to casino companies that operate in Macau, because Macau generates a huge amount of revenue for casino operators and it is talked about with much more frequency than any other region associated with casinos (with the possible exception of Japan during times when the casino bill is getting public attention).
Risk 1: Regulatory policies in mainland China- Two regulatory changes in China that have gotten a lot of attention recently are the “Smoking Ban” in Macau and restrictions on UnionPay cards at casinos:
- Counterpoint: What most people probably didn’t know is that “…Macau’s six casino operators — including MGM Resorts International, Wynn Resorts Ltd. and Las Vegas Sands Corp. — asked for the prohibition.” Why? Well, it’s fairly easy for the casinos to comply with the law, all they need to do is install smoke-free rooms on the mass-market gaming floors and not include any tables or slot machines in those rooms. Furthermore, “the government is not going to limit the size or the number of smoking rooms casinos can install in mass areas,” and providing smoke-free rooms will actually add to the “family friendly” service that casinos will be able to provide (probably why the major casino operators weren’t opposed to the regulation in the first place). In a report released on June 11, 2014, Citi analyst Anil Daswani was reported as saying that he and his team “…re-iterated their bullish call on Macau and said recent headline news concerns are overblown and the Macau stocks are oversold…’Given the installation of smoking rooms on mass floors, the full smoking ban on the mass market will likely lead to an immaterial ~2% decline in mass GGR, based on our smoking survey.’” Las Vegas Sands has already complied with this regulatory change, which was talked about at the end of the Q2 2014 Earnings Call.
Restrictions on UnionPay Cards at casinos- “Macau’s government plans to further restrict the use of China UnionPay Co.’s debit cards at casinos, curbing money flows to the world’s largest gambling hub by making it harder for bettors to buy expensive items that they exchange for cash.”
- Counterpoint: This is more of a curb on corruption than the government turning sour on casinos, as some people have proposed. The effect of this restriction has definitely already been priced into the market, with casino stocks majorly selling off during the trading days that this news gained traction, and the UnionPay card terminals should already have been removed (seeing as they were supposed to be removed before “…July 1, according to the head of SJM Holdings Ltd”). The simple reason why this probably won’t be a problem moving forward is that using UnionPay cards to exchange money in Macau only became widely practiced rather recently, and before that pawnshops were widely used to convert other currencies into HKD. Pawnshops were the main reason that UnionPay card terminals in casinos were even noticed by the Macau government, because pawnshop owners complained that they were losing business to the terminals. Even if UnionPay cards are banned completely, gamblers would just revert to using the pawnshops by buying expensive items in other parts of China and then selling them at pawnshops in Macau (to convert other currencies into HKD). UnionPay card terminals being banned completely seems unlikely, and Citi analyst Anil Daswani even said that “…we believe retailers in the nongaming areas will continue to be allowed to carry legitimate Union Pay terminals.”
Risk #2: slowing growth in Gross Gaming Revenue (GGR)- Right now, analysts are still trying to determine whether or not the World Cup was responsible for the decline in GGR growth over the last few months. Recently, a report came out indicating that “total gross gaming revenue dropped 3.7 percent to 27 billion patacas ($3.4 billion) [in June 2014].”
- Counterpoint: I believe that the World Cup did in fact have an effect on Macau’s GGR in the month of June, given that the World Cup caused GGR to drop significantly in 2010. However, it appears clear that the World Cup’s effect on GGR was not as severe this time as it was in 2010. I agree with analysts who “’’….expect gross gaming revenue growth to return to positive in the second half of 2014’” (Billy Ng, an analyst at Bank of America Merrill Lynch). The World Cup likely had the greatest impact on VIP revenue, which should affect other casino stocks in Macau far more than it affected Las Vegas Sands. I believe that the World Cup affecting GGR is really a one-off factor, and it has already played out for LVS (we will see how it affects the other casino stocks in Macau when they release earnings). Regardless, this is a short-term factor and I prefer to focus on the long-term when it comes to investing in casino operators.
Risk #3: High Leverage- Casino operators have a high amount of leverage, and if they are not able to pay it back (or interest rates on loans rise substantially) it will hurt the company and its stock price as a result.
- Counterpoint: It’s definitely true that casino operators naturally have more debt (higher leverage) than companies in other industries. This all comes back to the table that shows some “Financial Health” data for LVS and its competitors. While other companies might not be able to pay off their debt, LVS has been easily paying off its debt while still returning capital to shareholders via dividends and stock repurchase programs! I can’t really tackle this risk, anymore than I already have in the financial health data, and this risk needs to be evaluated on a case-by-case basis. I will say that Las Vegas Sands currently has “…plans to restructure a portion of [the company’s] obligations,” and “Wells Fargo Securities gaming analyst Dennis Farrell Jr., who specializes in high-yield bonds, said Las Vegas Sands and Wynn Resorts Ltd. have the best credit profiles of any of the major casino operators.”
“Tune Out The Noise And Focus On The Opportunity”
Over the last two months, a lot of reports have come out about the casino industry (and Macau in particular) that caused the stock prices of major casino operators to decline by roughly 15% on average from their prior highs. Many of those reports were analysts downgrading stocks in the industry (from “Buy” to “Hold,” etc.) and providing new price targets. All of that is customary when an entire industry is experiencing a correction, and those reports coupled with terrible underperformance relative to the rest of the market has lead to a lot of negative sentiment towards casino operators. This presents investors with a great long-term entry point, because casino operators are now trading at a nice discount relative their valuation at prior highs. Investors are able to capitalize on this if they are able to tune out the “noise,” because that’s all I really consider analyst re-ratings and changing price targets to be- noise.
Valuing LVS and Other Casino Operators:
Before discussing valuation multiples for LVS, it’s worth noting that valuing casino operators using normal valuation multiples is extremely difficult given the huge amounts of money flowing through them in any given year.
The three things that I chose to look at when valuing casino operators are Enterprise Value (EV), Free Cash Flow (FCF), and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). I already described why I think FCF is important for casino operators, so I won’t go into it any further. I chose to look at casino operators’ Enterprise Values, rather than their stock prices or market caps, because Enterprise Value incorporates cash (and cash equivalents) and debt. I calculated each casino operator’s Enterprise Value in the following manner: Enterprise Value = (Market Cap + Total Debt) – Total cash and cash equivalents. I looked at EBITDA because it is a very commonly looked at number, and the EBITDA numbers that I used for my calculations were actually each casino operator’s Total Adjusted Property EBITDA. I looked at that number because I think it is the most accurate number for casino operators in terms of EBITDA.
The two multiples that I calculated, and show below, are Ev/EBITDA and Ev/FCF. The Ev/FCF multiple probably isn’t as reliable as the Ev/EBITDA multiple, because casino operators’ FCF numbers tend to vary significantly every year, but I believe that it is extremely important to look at a casino operator’s FCF (as I previously mentioned). I just wanted to say that before getting into the valuations.
I added some more “Notes,” which are basically disclaimers, below the following charts to give some more information for how the multiples were calculated.
- Note #1: The data goes from Q1 2009 to Q1 2014, because that five year period gives the most pertinent information for casino operators, but the chart’s data begins in Q4 2014 because the EBITDA and FCF values are for the last four quarters (Twelve Trailing Months). The multiples are calculated for each quarter using the Enterprise Value (EV) at the end of the quarter and EBITDA (ttm) and FCF (ttm) values.
- Note #2: I calculated all of the values myself by looking at the 10-Q and 10-K filings for each company. I did not include CZR in the graphs, because including it would have significantly through off the average values for each chart. I also did not include MPEL because the company is based in China and is not mandated to submit a 10-Q or 10-K filing to the SEC.
- Note #3: The EBITDA values used are actually the Total Adjusted Property EBITDA values given in each company’s 10-Q or 10-K filing. Enterprise Value (Ev) was calculated as: Enterprise Value = (Market Cap + Total Debt) – Cash and cash equivalents. Free Cash Flow (FCF) was calculated as: Free Cash Flow = Operating cash flow – Capital expenditures. The share price, used in the Market Cap calculation, was simply the historical closing share price I found on Yahoo Finance (not adjusted for dividends or splits) for the effective date of the 10-Q or 10-K filing. For example, I used the company’s closing share price on March 31, 2010 for calculating the company’s market cap for Q1 2010. For the number of shares outstanding, used in the calculation of market cap, I used the Weighted Average number of shares outstanding (fully diluted) for the quarter, which is the same number of shares outstanding used when calculating Diluted EPS.
- Note #4: The “Average Multiple For All Stocks” line (the red line in all four of the graphs) is just the average multiple for all the stocks in the graph for the entire period that the chart shows. Therefore, in the “Quarterly Ev/EBITDA (ttm) Multiple For LVS” graph, the average multiple line simply shows the average Ev/EBITDA (ttm) multiple for the entire period shown (Q4 2009 through Q1 2014 or 18 quarters in total). Likewise, the average multiple line in the “Quarterly Ev/EBITDA (ttm) Multiples For All Stocks” graph is the average multiple over the 18 quarter period for all three stocks shown.
- Note #5: The Ev/FCF graphs only go from Q3 2011 to Q1 2014 because the multiples for all the quarters before Q3 2011 were so high that they would have thrown off the entire thing. Therefore, looking at the shorter historical period would be a better indicator of future multiple ranges.
- Note #6: The most recent Ev/EBITDA and Ev/FCF multiples for LVS (the ones circled in the charts) are only approximate figures, which were calculated using some information (EBITDA, Total cash and cash equivalents, Total debt, etc.) that I found in company reports for Q2 2014 and some information (cash from operations, total capital expenditures, etc.) from the company’s 10-Q filing for Q1 2014. I did this to provide an approximate multiple calculation that is up to date, but it isn’t 100% accurate because the company hasn’t submitted a 10-Q filing for Q2 2014 yet.
Interpreting The Valuation Multiples
I decided not to attempt to do a Discounted Cash Flow (DCF) valuation for Las Vegas Sands because the legalization of casinos in Japan is a huge long-term catalyst for the entire industry- trying to project future cash flows over the next five years would be completely futile right now. At this point in time, we cannot know for certain how much market share LVS will be able to gain in Japan, or whether or not casinos will even be legalized in Japan at all, so it is impossible to try to predict future cash flows for LVS given that lack of information. All I want to do with the valuation multiples is to determine whether or not LVS is “undervalued” or “overvalued” RIGHT NOW.
The graphs of historical Ev/EBITDA and Ev/FCF multiples, and long-term average multiples, help investors determine whether or not a stock is currently “fairly valued.” Basically, if the stock currently trades at a multiple that is below its own long-term average multiple then it would appear to be “undervalued,” and if the stock currently trades at a multiple that is above its own long-term average multiple it would appear to be “overvalued.” A price target can then be derived by calculating the price that the stock would be at if it reached its own long-term average multiple. The same sort of thing can be done when one compares a stock to other stocks in the same industry (so long as they are affected by the same economic factors and move in roughly the same direction over shorter periods of time). In that circumstance, an investor would compare the multiple that a stock is currently trading at to the long-term average multiple that stocks in the industry (including the stock selected) have historically traded at. If the stock currently trades at a multiple that is below the long-term average multiple that stocks in the industry have historically traded at then it would appear to be “undervalued,” and if the stock currently trades at a multiple that is above the long-term average multiple that stocks in the industry have historically traded at then it would appear to be “overvalued.”
That seems simple enough, but it is extremely difficult to devise an accurate price target from just looking at that information (especially if the multiples fluctuate as much as Ev/FCF multiples do). The best thing that the information will tell you is roughly whether or not a stock is currently “undervalued” or “overvalued” when comparing its current multiple to a historic average multiple. The recent sell off in casino stocks caused LVS to become “undervalued” when comparing LVS’s current Ev/EBITDA multiple (approximate calculation for Q2 2014) to its long-term average Ev/EBITDA multiple. If you compare LVS’s current approximate Ev/EBITDA multiple (12.91 if you use LVS’s closing price on July 29, 2014) to its average multiple over the last 19 quarters (14.10 if you look at Q4 2009 through Q2 2014) then it would appear that LVS is approximately 5% “undervalued.” That figure was calculated by figuring out how much LVS’s share price would need to go up to have an Ev/EBITDA (ttm) multiple of 14.10. A 5% increase is not significant by any means and it’s completely arbitrary. The number would be much larger if you compared LVS’s current Ev/FCF multiple (18.25) to its long-term average multiple (29.17), but I don’t think it would be quite as accurate. The only thing that an investor can accurately interpret from the graphs above is that LVS is currently slightly “undervalued” on a historic multiple basis, and LVS is currently trading at lower valuation multiples than most of its competitors.
LVS Basic Technical Analysis/Chart Analysis:
Note: Data as of July 30, 2014
There’s nothing complicated in that chart. The recent correction that was experienced throughout the stocks in the Resorts & Casinos industry knocked LVS out of its 18 month uptrend channel, and began a series of “lower highs.” The chart shows that LVS is currently at a major turning point, either it will break support in the $68-$70 region and then head lower or it will break above the new downtrend line and re-enter its uptrend channel. Either situation is possible. To be honest, I wouldn’t mind seeing LVS break support and head lower, so that I can scoop up more shares at that lower price. I am confident in LVS’s long-term potential, but right now LVS needs to make a decision and pick its direction.
Regardless of how one interprets the graphs above, I believe that LVS’s current price offers a very attractive long-term entry point, and LVS’s share price will significantly appreciate in value over the next five years or more. About two months ago I made a prediction, in Volume I, Issue 12 of my Financial Newsletter, that the stock market (or rather the S&P 500) would experience a 10-15% correction that would begin in July or August. Therefore, it is a big deal to me that I am recommending that people consider buying shares of LVS even though I am short-term bearish on the market as a whole. If I am correct and the market experiences a correction, then investors will (ideally) be able to buy shares of LVS at a lower price. If I’m wrong, and the market does not experience a correction, then investors should see LVS move higher in the months to come.
I believe that LVS’s current share price offers a fantastic entry point for long-term oriented investors, and I recently initiated a long position myself.
I will release a follow-up article that focuses on stocks in the Resorts & Casinos industry.
If you have any questions about this Issue of my Financial Newsletter please fill out the form below. I also appreciate receiving any comments you might have about what you just read, and I encourage you to send me ideas for topics that you would like to see me write about in the future. Thank you for reading!