Wynn Resorts: What Happens If Recovery In Macau Gaming Comes Sooner?

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Wynn Resorts’ (NASDAQ:WYNN) stock has declined over 12% so far in August. This can primarily be attributed to its earnings release and continued uncertainties pertaining to Macau gaming. Wynn, like other casino operators, has lowered minimum bets and moved more tables from VIP to mass-market gaming in recent quarters. However, its gross gaming revenue decline has been very steep (more than 35% in the first half of 2015), weighing heavily on the top line and bottom line. While the decline can be attributed to multiple factors, including the anti-graft measures taken by Beijing, the industry outlook still remains positive. We continue to believe that an increase in visitation from Mainland China and continued growth in income levels will fuel casino demand in Macau. If the recovery is steeper than estimated, it will result in more than 10% upside to our price estimate for Wynn. There is a fair probability that the recovery in Macau may kick in soon. Below we explain why.

See our complete analysis of Wynn Resorts’ stock here

Recovery In Macau Should Kick In Soon

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The decline in Macau gaming has been steep and was unexpected in summer 2014. Wynn itself was trading north of $190 through October last year as compared to $90 currently. The decline started with anti-graft measures from Beijing, which kept VIPs away from Macau. Further measures, such as a smoking ban and visa restrictions added to the woes of casino operators, and gross gaming revenues plunged more than 35% consistently since February this year. Since Macau’s economy is heavily dependent on casinos, its GDP also dropped 25% in Q1 2015. Everyone expects a pick up in gaming, but it is difficult to estimate when it will kick in. Given that the market has seen consistent 30%-plus declines since February, and monthly gaming revenues have been stable in the range of $17 billion to $20 billion for most of 2015, the comparison will be favorable starting in 2016. Recently, Lui Che-woo, Chairman of Galaxy Entertainment Group, stated that the worst is behind us and the recovery should kick in in the near term. [1] Of late, there have been a few positive developments from Beijing as well; the visa restrictions have been relaxed and a smoking ban will likely be delayed. These developments do point towards a recovery sooner than later.

Key Drivers For Gaming Growth

Macau is the only place where gambling is legalized in China. People travel from different states in Mainland China and Hong Kong to Macau for gambling, which is unlikely to change. Mainland China visitors to Macau have doubled since 2005. China’s personal disposable income has also grown at an average annual rate of 12% during the same period. The growth in visitors and income levels is likely to continue, albeit at a slower pace. Furthermore, there are key infrastructure initiatives being taken by the government such as connecting Macau and Cotai to Hong Kong, thereby reducing the travel time and boosting visitation. These projects will be completed in late 2016. These factors will push the demand for gaming in the coming years and accordingly, we remain bullish on the long-term Macau story.

Mass Market Will Drive Wynn’s Future Growth

Unlike Las Vegas Sands (NYSE:LVS), which relies more on mass-market and non-gaming operations for profits, Wynn derives a significant portion of its profits from VIP gaming. We estimate that VIP gaming accounts for 20% of Wynn’s stock value. This can also be attributed to the premium casino image that Wynn has established in the region. In the current environment, it is not a good tilt given that most of the recent decline in gaming is on the VIP front. Accordingly, Wynn has been aggressively pushing to expand in the premium mass segment.

In the past few years, most of the VIP gaming in Macau involved high ranking government officials, bureaucrats and executives at the state-owned companies. Given Beijing’s anti-corruption crackdown since last year, VIPs have stayed away from Macau. This is likely to be the new normal in Macau. Accordingly, we expect a massive expansion on the mass gaming front and a decline in contribution from VIP gaming.

Potential Upside And Downside Scenarios For Wynn

We currently estimate the mass-market table drop to decline by 20% in 2015 amid the recent slowdown in Macau. However, we expect to see strong growth thereafter, and see volume double by 2022 from the $2.65 billion levels seen in 2014. This will result in revenues of over $2.4 billion for Wynn. It should be noted that Wynn is developing a new resort in Cotai which will be operational next year and boost the company’s market share in the region. An estimated EBITDA margin of 30% for Wynn’s Macau casinos will translate into EBITDA of $730 million, representing close to 25% of the company-wide EBITDA.

However, if the recovery is steeper than estimated and the table drop is north of $7 billion, it could result in a 10% potential upside to our price estimate for Wynn. On the other hand, if the market remains rangebound with slower growth and the table drop is under $4 billion, it would result in a 10% potential downside to our price estimate.

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Notes:
  1. Lui Che-woo: Worst over for Macau gaming industry, EJInsight, Aug 20, 2015 []