Our Revised Price Estimate of $27 For MGM Resorts

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MGM Resorts

We have revised our price target for MGM Resorts (NYSE:MGM) stock from $24 to $27, which reflects a change of around 10%. The current valuation reflects our revised estimates of MGM’s casino operations in Macau. We believe that the company’s casino operations in Macau will continue to see some pressure in the coming months amid the ongoing anti-corruption crackdown in the region. However, we believe the growth in this segment will resume next year and partly will be driven by its new casino resort in Cotai, which will further enhance its market share in the region. We continue to remain bullish on Macau gaming in the long run primarily due to the fact that there is a massive growth potential in visitors from Mainland China.  Contributing as well in the growth of high net-worth individuals (HNIs) and the burgeoning Chinese middle class. Our revised model also reflects the company’s performance in 2014 and our revision of the company’s cost of capital.

We now estimate a $0.33 EPS for MGM Resorts in 2015, which is in line with the market consensus of $0.10-$1.01, compiled by Thomson Reuters. We currently have a $27 price estimate for MGM Resorts, which is more than 15% ahead of the current market price.

See our complete analysis for MGM Resorts International

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Expect Macau Gaming To Decline In 2015

We believe that the situation in Macau will remain fraught in the near term and it will continue to have an unfavorable impact on VIP gaming in the coming months. As we know, 2014 was tough for all the casino operators in Macau and it marked as the first full year of gross gaming revenue decline. The primary reason for this drop is the government’s anti corruption crackdown. A wave of high-profile arrests of senior Chinese officials has hurt the VIP business of Macau casinos. Visa transit restrictions, a smoking ban and the weakening economy added to the woes for casino operators in the region. Moreover, Beijing wants Macau to diversify its economy, which is largely dependent on gambling; gambling in fact accounted for 80% of the local government revenues in 2013. Macau operations account for more than 30% of MGM’s value, according to our estimates, and any volatility in the region will impact the company’s stock price.

MGM China’s casino revenues declined 1% to $3.24 billion in 2014 and we expect it to further drop by 10% to $2.92 billion in 2015.  However, we expect it to pick up from 2016, when the company’s new Cotai resort will be operational. While the gaming situation in Macau may be fragile in the near term, we expect casinos to do well in the long run, given that Macau is the only place in China where gambling is legal. Also, gambling in China is an accepted practice in the home as well as in social circles. China is seeing growth in the number of HNIs, but only a small portion of them visits Macau for gambling. China currently has about 1.3 million HNIs with a combined wealth of $4.3 trillion. As China continues to grow, more people will likely visit Macau for gaming activities and MGM as well as other casino operators should thus continue to benefit from the rising demand, as they did in the past.

Lower Weighted Average Cost Of Capital

We have revised our discount rate (or weighted average cost of capital) downwards for valuing MGM Resorts’ stock. This is the rate at which we discount the company’s future cash flows, and is the weighted average of its after-tax cost of debt and cost of equity. This figure is a measure of a company’s risk. MGM Resorts justifies this revision as the stock’s beta has come down in the past year. Beta is a measure of company’s stock volatility relative to broader market. MGM’s correlation to the broader market has improved, which means that the risk of fluctuations in its stock price has come down. The company has also been able to stabilize its business and increase its revenues in the last few years without taking on substantial debt. This reduces the risk in the company and warrants the revision. It must be noted that MGM has spending restrictions as it has to honor the maximum capital expenditures covenant clause of $500 million imposed by the senior credit debt holders. The company was limited to $500 million of capital expenditures in 2014. However, any unused amount can be rolled over to the next fiscal year.

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