MGM Resorts: Dip Signals A Buy As Value Scenario Grows With Sector Recovery

Alina555

"Good merchandise, even hidden, soon finds buyers…"

Plautus, Roman playwright (d.184BC)

FOLLOW UP: On May 3rd, we published a buy recommendation on MGM based on our thesis that the company's multiple verticals in the gaming sector positioned it for a move from a general dead pooled price of ~$43 to a PT of $67. Since then, there has been a wide publication of reports by key participant companies in the travel/leisure sector which have added a strong positive tone to the rationale for the stock based on factors cited by hotel and travel companies who see a strong vacation breakout coming. In other words, the tailwinds have gotten stronger, and by adding to the bullish outlook within the industry itself, it caused us to note this change for readers in this piece.

Secondly, there have been reports by Macau authorities since that piece that confirm the continuing sequential growth of monthly revenue gains that include the most recent for May that indicates near a $2b GGR. This new data reinforces our case that MGM China's recovery is moving even faster than was the case in my prior article. This too changes the state of play as it were in the sense that Macau is heading to a much closer arrival at pre-Covid revenues that had been the case. Overall, the sentiment we expressed on May 3 here on SA has grown more positive and we wish to note that for readers.

Yet, despite this growing positive outlook, shares of the company have dipped to ~$40 and we believed that represented a buy signal strengthened between the time of our original article and this one.

The shares of MGM Resorts International (NYSE:MGM) have seemed to puzzle Mr. Market for far too long given its solid positioning, recovering earnings profile, and most of all, its participation as a major player in every key gaming sector post Covid. The shares had traded as low as $16 in July of 2020 when Bill Hornbuckle was promoted to the CEO spot after the departure of Jim Murren in February of that year.

From that Covid-related nadir, the shares moved steadily north propelled as the Covid disaster began to ease in Las Vegas and by the deft managerial moves made by Hornbuckle and his key associate CFO Daniel Halkard. Early last month, the stock traded at a high of $46. We guided buy at $43 early last month. At writing, the stock is $41. We believe the dip suggests some options activity and other trading moves, not a definitive expression of market sentiment overall.

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Yet, taking a deep dive into the stock and the macro head and tail winds in the economy in general and specifically the sector, we continue to conclude that, by most reasonable measures, MGM is among the most undervalued stock in the gaming and leisure sector. Why its attributes at its price range appear to miss the attention of investors seems to me to be rooted in the recent past, not the forward momentum.

One of the key engines that will contribute mightily to the forward momentum of MGM shares is the simple facts and direct evidence that the overall leisure sector is headed for a total restoration - if not beat - of the pre-Covid numbers. But investors remain wary.

The hotel/travel sector is expected to score record passenger demand for the July 4th weekend, and afterward for the full year. Marriott (MAR) reports strong demand on forward bookings across the board of its properties. Despite - frankly - crazy, inflated room night rates - Hilton also reports consumer demand still rising. Expedia (EXPE) says its searches are up 25% in the June through August period.

American Airlines (AAL) has lifted its 2Q23 earnings outlook from $1.20-$1.40 to $1.45-$1.65. That sunnier forecast is due to two factors: One, an easing of fuel prices; and two, the rev par per available seat (the gold standard metric for airline activity) looks far more favorable going forward.

Labor and supply chain shortages continue to impact the sector, but overall availability of flights, rooms, and facilities is moving up. We see the edge of pent-up demand here continuing to drive its part of an overall positive picture for leisure and business travel. Several hotel/convention executives we spoke to repeated the mantra that regardless of the massive move to online conduct of business triggered by Covid, they are finding that companies still contend that face-to-face contact is essential to the future of all business.

This, in brief, is good news for the industry. Evidence of this is the results of 1Q23 quarter of a record-breaking $16.6b in total gaming revenue across the nation, the 8th straight month of increase. The figure breaks down thusly: Land-based casinos *7.7% or $12.3b, sports betting up 20% to $2.79b, and iGaming tracking at $1/45b.

Given MGM's fortress Las Vegas footprint and its key regionals in the US, their prospects for a powerful forward earnings profile are strong and getting stronger.

The first five months of this year, Macau GGR was up 178% from 2022 to $8.05b when it was still heavily dragged by Covid bans imposed by China's zero policy, not ended until January 6th of this year. This revenue flow was achieved despite growing evidence of a significant slowdown of the China economy. Again, we have the engine of pent-up demand at work plus the saved bankrolls among players who have begun to return.

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Each month's GGR since the lifting of the ban has shown sequential increases with May's number scratching the $2b mark at $1.93b - a post-pandemic high, a 366% y/y increase, and up 5.7% from April. Our projections are that monthly GGR will continue to show sequential gains closer to pre-Covid seasonal levels. The first four days of June, as expected, show a 10% decline, totally consistent with pre-Covid seasonal levels.

Our projections now show that, on a seasonally-adjusted basis, Macau monthly GGR will attain 80% of pre-Covid revenues by 3Q23 or before. That would put it at $2.4b, and we believe, by mid-Q4, equal to or 3% ahead of pre-Covid levels. The 2019 Macau year tracked roughly $3b per month.

Our best estimate now based on our on-the-ground associates in the market was that MGM's share of the Macau market should reach ~12% of GGR before the end of the year, putting their run rate ahead at ~$360m in gaming win plus our estimate of another 10% in non-gaming, to a total of~$400M, reaching our forecast of $1.2b in total revenue as a realistic target for 2024.

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BetMGM, among the strongest casino-operated sport betting verticals, won an estimated $470m in 2022 in the US and is forecasting ~$1.8b by early 2024. Management believes the vertical will turn profitable before the end of this year. MGM owns 50% of the operation in partnership with the UK's Entain (ENT.L). Its partnership history (Borgata AC) indicates its probable long-term interest in making another try at acquiring Entain, or moving toward a possible buyout. Meantime, turning profitable this year will provide cash flow relief from excessive marketing costs.

Without a blaze of mind-numbing metrics here, we have simply tried to show that MGM's broad-based footprint is being driven in part by macro factors that we believe are positive for the stock. We're not twirling pom poms here. Of course, recession fears continue to loom, if not getting dangerously close. If you look at the economic contradictions between job growth, higher Fed rates, slowing productivity, supply chain and labor shortages, China's rapidly declining GDP prospects you can easily make the case now to stay in cash or high-quality bonds.

On top of that, there are still sectors of market players with residual concerns about MGM debt. And we think therein lies the core hesitancy of investors to move on the stock when they compare MGM's debt levels to key peers:

In its recent past ratings, Fitch has cited its less-than-stellar outlook on MGM citing the uncertainties of concession renewal prospects for its Macau properties prior to the end of last year. Since then, of course, all six concessionaires have been renewed for 10 years. Some aspects of the renewal terms may appear to tighten oversight by the Macau government, but overall, our on-the-ground associates agree that the final deal is far better than anyone had expected. With that uncertainty removed and a slowly improving debt profile and pace of revenue recovery, we think it no longer figures as a major bearish factor in the stock.

MGM current ratio: 2.1 is a fairly good indicator that the company's balance sheet is healthy enough to provide its contribution to a margin of safety at the level at which MGM has been trading.

The entire peer group noted above all share many positive outlooks without question. Yet, it is our contention that the spread of verticals within the gaming/leisure sector makes a very powerful buy scenario at MGM's trading range. In short, it is relatively cheap exposure to all aspects of gaming that are on a positive run ahead.

Las Vegas Sands (LVS) is great, but it is not yet in sports betting or regional casinos in the US, nor does it have a presence in Las Vegas. Its Asia footprint stands as a great fortress ahead. We think the stock here is also undervalued, but not to the extent of MGM.

Wynn Resorts (WYNN), as we have noted before on SA, has a long history of punching above its weight in terms of its stock price history. That stems from the long-standing high confidence of investors in the genius of former CEO/Founder Steve Wynn. Now, without him since 2018, the company has managed through the Covid crisis and is expanding. But its only US regional presence is in Boston (Realty sold to a REIT) and its sports betting vertical is a fringe operator in that space.

PENN Entertainment (PENN) - among the best US regional operators, no meaningful presence in Las Vegas and no Asia presence puts it at the front of best bets in the US gaming sector. Its sports betting unit, Barstool Sportsbook is reaching profitability on a marginal market share - all to the good.

52-week range: $26.41-$46.37

Market cap: $15.019b

We note here without question that the single driving force that has moved MGM, as it has all Macau-facing stocks, was China dropping zero Covid last January 6th. On that day, MGM traded at $37.35. Since last month, MGM has dipped slightly, opening what we believe to be a buy opportunity.

MGM is currently trading at 7.7X P/E vs. 14.5X for the market with earnings up so far at 299% y/y. Of course, the reversal is against the still Covid infected 1Q22. Yet, it shows that, as sunnier outlooks are unleashed against all MGM sub-sectors, the stock is clearly undervalued.

Our discounted cash flow price calculation puts the stock at $63.50. Alpha Spread puts a base case intrinsic value of $74.46 on MGM. Analyst PT on the stock is ~$57. We see a far more rapid pace of recovery in both Macau and US regionals joining the surge already evident in Las Vegas.

We see a clear path of MGM to $64 by 3Q23. We think 2023 revenue can reach between $15.8b and $16b moving to near $17b in 2024. Given the chaotic tone of the market these days, we acknowledge that the wariness of companies with high levels of debt in what will be continuing upside Fed pressure on rates governs decisions regardless of sector outlooks.

Of all, the potential headwinds that could buffet the sector in general and MGM specifically, a prolonged, deep recession looms as the biggest risk. We may actually face something far worse: A full employment recession enabled by continuing challenges in supply chain inflation and labor shortages. But if the past is prologue in this business, and I have a many decade past in gaming which informs my views, gaming leisure persists as among the most resilient human proclivities over time.

For in-depth and deep dive research on the casino and gaming sector, subscribe to The House Edge. New: Free excerpts from our book in progress "The Smartest ever Guide to Gaming Stocks" - free to existing members and new subscribers.

This article was written by

For 30 years I held senior vp and exec VP positions in major casino hotel operations among them Caesars, Ballys, Trump Taj Mahal and have done extensive consulting assignments for many others in the US, including the native American property Mohegan Sun, in Connecticut. I have also done special projects for Caesars Palace in Las Vegas. I was the founder and publisher of Gaming Business Magazine, first ever publication covering the gaming industry and have written extensively about the industry.

Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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