On Monday I gave a general overview of what Wall Street analysts think of gambling stocks. For the most part, their opinions mirror those of most gambling insiders. (Macau still good, US not so much.) But much of what analyst opinion does become public knowledge is relatively limited: Goldman Sachs might upgrade a stock from “Neutral” to “Buy,” for instance, or an analyst from Jefferies might appear on CNBC to bless a merger or question a company’s long-term health.
It’s less often that investors – particularly individual investors – have the opportunity to see the depth of data Wall Street analysts use, and the models they have designed to value stocks. Late last month, Wells Fargo analysts released their “Gaming Model Book,” covering 12 stocks in the gambling sector. The 156-page report has a wealth of detail, going well beyond individual stocks; its 112 exhibits cover everything from occupancy rates and average room prices in Macau to airport arrivals at Las Vegas’ McCarran Airport to forecasts of slot machine market share in North America.
The density of the data in the report and the technical nature of the valuation strategies make the report a rather dull read, but there are some interesting nuggets in the Wells Fargo data. Notably, the brokerage gives just three of the thirteen stocks in its coverage universe an “Outperform” rating, with the nine remaining companies rated “Market Perform.” Interestingly, two of the suggested buys in the sector are stocks on which I’ve been rather bearish: MGM Resorts International (MGM) and International Game Technology (IGT). Even MGM bulls have been somewhat cautious on the company’s prospects; as I noted on Monday, Jake Fuller of Lazard Freres gave the stock a “Buy” rating while still noting the company’s high debt level – some $13 billion – and the risk of a continued slowdown on the Las Vegas Strip. For its part, Wells Fargo largely dismissed both concerns. “We are positive on MGM given its leverage to the LV Strip recovery,” the firm wrote, also noting that the cash generated from MGM China – the company’s Macau-facing subsidiary – would help pay off the parent company’s extensive debt load.
Wells is not necessarily predicting an unusually strong rebound; both gambling win and food and beverage sales for MGM’s Las Vegas operations are expected to grow just 3-4% annually in 2013 and 2014. The brokerage is more optimistic about room revenues, noting repeatedly that the room supply on the Strip is essentially capped for the near future, allowing for potential increases in room occupancy rates and RevPAR (revenue per available room). RevPAR at MGM is forecast to increase nearly 14 percent over the next two years, from $118 in 2012 to $133 in 2014, with occupancy projected to hit an astonishing 95.7% two years from now.
According to the firm, that hotel revenue growth should drive higher margins, and higher pre-tax earnings, for MGM, increasing cash generation and allowing the company to not only pay the substantial interest on its debt – over $1 billion in 2012 alone – but pay down some of that debt going forward. And yet, Wells’ bullish scenario for MGM still doesn’t look all that rosy. The firm still forecasts a net loss for MGM in 2014 – though the company should generate positive free cash flow – as reduced, but still significant, interest expense of over $800 million overwhelms the company’s increased EBITDA (earnings before interest, taxes, depreciation, and amortization.) In short, the upside doesn’t seem to justify the risk. Leverage works both ways; and a double-dip recession in the US or even the failure of MGM to post the occupancy and revenue growth predicted could threaten the company’s very viability.
As for IGT, Wells Fargo is very bullish on the stock, with its 12-month target price range for the stock between $14.50 and $17.50 per share; even at the low end, that would represent nearly a 20% gain from Wednesday’s close of $12.21. I have criticized IGT as a company that has lost its way, though Wells disagrees, calling the company “best in class” and noting its “significant FCF [free cash flow] generation” and “resurgent market share.” That free cash flow is not quite as impressive as the analysts make it sound; indeed, Wells still values the stock at 13-15x its 2013 FCF, a surprisingly high multiple given that the brokerage is forecasting IGT’s 2014 earnings and revenue to fall from the year-prior period.
American ship share at 34% in 2012, up from 28% in 2010. Yet Wells forecasts a small slip for IGT in 2013, largely due to weakness in the replacement market, and it’s worth noting that IGT’s market share has been halved over the last decade from a dominant 65% position in 2004. Again, IGT looks like a struggling, low-growth company that is having difficulty fighting off its smaller, more innovative competitors. Those types of stocks often receive a multiple in the range of 10 times forward earnings. In IGT’s case, fiscal 2013 earnings are forecast by Wells Fargo to be $1.22 per share; at 10x forward earnings, IGT would be valued at $12.20, one cent below Wednesday’s close.
The Wells Fargo industry-wide data does show IGT’s dominance in one area: video poker. IGT has a stunning 93% share of the installed poker base in North America, with Bally Technologies (BYI) in second place with a paltry 2.5 percent. IGT’s share in the installed base of video gaming units is far less dominant; while still in first at 32.3 percent, it is being trailed closely by Aristocrat Leisure (ALL.AU) and similarly struggling WMS Industries (WMS). Overall, the Wells Fargo data shows little change in market share over the last few years; WMS has seen its share of the market dwindle, but the only clear winner is Konami Corporation (KNM), whose ship share has risen from 11% in 2009 to 15% in 2012. Market share has become key amongst slot machine manufacturers, because the industry’s overall growth continues to slow. Wells Fargo is projecting replacement sales growth of just 3% industry-wide in 2013, the lowest level since replacement sales plummeted during the 2008-09 financial crisis. New unit growth is predicted to be around four percent, while new unit shipments will likely remain below the level of 2009 and about half the level in 2008.
Share is key not just among slot machine manufacturers, but their customers – most notably in Macau, where fears of a slowdown on the island have led to lowered stock prices for the island’s operators. Wells Fargo does maintain an “Outperform” rating on Melco Crown Entertainment (MPEL), citing its inexpensive valuation at just 16 times 2013 estimated earnings per share. But it cited fears of below-consensus performance in Macau in giving “Market Perform” ratings to Las Vegas Sands (LVS) and Wynn Resorts (WYNN).
But on a market-share basis, those two companies seem to have diverged, according to Wells Fargo data. Sands, in part due to its spring opening of Sands Cotai Central – whose second phase opens this month – is the new share leader on the island. Sands took 27.2 percent of gaming revenue in July, taking the crown from SJM Holdings (SJMHF.PK). Wynn, meanwhile, has seen its share dwindle from a peak of 16.8 percent in April 2011 to just 11.3 percent in July. Wynn’s own Cotai project may jump start revenues, but Sands has a clear head start and should maintain its lead for the near future, particularly as the second phase of Cotai comes online.
Of course, its not share that has concerned analysts about Macau, but the growth in the overall market. Those fears came to a head when year-over-year growth in July fell to just 1.5 percent, its slowest growth since 2009. August was the second-highest month on record, but year-over-year growth remained modest at just 5.5 percent. For its part, Wells Fargo is expecting better days ahead; 2013 revenues are projected to rise 12 percent, led by 29 percent growth in mass market table gaming revenue and a 20 percent rise in slot win. Interestingly, the brokerage is projecting total tables in Macau to rise to 5,700 in 2013 and 6,100 in 2014; both figures are over the 5,500 table cap currently set, with allowances of 3 percent annual growth. It would appear that Wells Fargo backs the growing consensus that the table cap is becoming largely “mythical.” That said, its analysts are less optimistic about slot growth on the island; the number of machines is projected to rise just over 20 percent – total – from 2012 to 2016, defying hopes that slots might make more substantial penetration on the island.
Still, Wells Fargo’s data shows reasons for optimism in Macau. Gross profit per mass-market table was sharply higher in the second quarter versus their VIP counterparts; with growth in mass market revenues sharply outpacing the growth in VIP win, margins for Macau operators should rise as mass market penetration continues. And while Wells Fargo is pessimistic on slot machine unit growth, slot revenues have grown 18% year-over-year in 2012, potentially providing another boost to margins – and profits.
In short, much of the detailed Wells Fargo data and projections echo the stance taken by many Wall Street analysts toward Macau: the recent slowing in revenue growth is not necessarily the end of stock price growth for the island’s operators. Macau is maturing, but hardly collapsing, and the move toward mass market gaming and nearly-untapped retail and MICE revenue streams mean that profit growth could outpace revenue growth in the near term.
In the US regional market, Wells Fargo stands similarly in-line with its Wall Street colleagues. As I noted on Monday, sell-side analysts are relatively lukewarm on US regional operators, with most of the companies receiving “Neutral” ratings from analysts. Wells Fargo is no different, giving “Market Perform” ratings to all five US regional operators it covers, noting the uncertain US economic environment and the competition in new and existing markets. Regional casinos did show first-quarter growth of 6.7 percent in the first quarter, but it dipped to 3.1 percent in the second quarter, according to the firm.
Overall, there’s little new in the Wells Fargo report. There are reasons for optimism in the gambling industry; and reasons for caution. As I’ve noted before, economic fears strongly impact gambling stocks, and Wells Fargo’s ambivalent attitude toward the sector reflects those fears, both in Asia and the US. That attitude is shared not just by its fellow analysts, but by commentators and even executives in the sector. Unfortunately, no amount of research can allow a brokerage firm to see the future; but the mountain of data put together by Wells Fargo can help investors make a more educated guess.