Domestic Hotel And Macau Casino Operations Will Drive MGM’s Future Growth

MGM Resorts (NYSE:MGM) Q2 results reaffirm our expectations but, at the same time, warrant a change in valuation primarily due to the company’s recently revealed profit growth plan. We continue to believe that MGM’s domestic hotel operations and Macau’s casino operations will drive the company’s future growth. This growth will come from a higher convention mix and events at the domestic properties, while Mainland China visitor growth and higher income levels will boost MGM’s Macau operations. We currently estimate gross revenues of a little under $10 billion for MGM Resorts in 2015, with EPS of $0.46, in line with the market consensus of $0.48, as compiled by Thomson Reuters. We currently have a $25 price estimate for MGM Resorts, which we will soon update to incorporate the recent quarterly earnings.

See our complete analysis of MGM Resorts’ stock here

High Convention Mix And Events Can Provide Sustainable Growth For MGM’s Hotels At The Strip 

We estimate that domestic hotel operations account for 35% of MGM’s stock value. MGM has a massive room supply at the Las Vegas Strip, while it is expanding its casino resort properties in other states as well. For any hotel operator, what drives the business is the average daily rate (ADR) and occupancy level. Despite a high room supply of 36,000, MGM has been able to maintain occupancy levels of over 90%. It must be noted that occupancy is a more important consideration than ADR for casino operators as they are motivated to sustain occupancy in order to generate demand for the casino and other ancillary facilities, thereby compromising the ADRs. Accordingly, MGM’s ADR hasn’t seen much growth in the past few years and are still much lower than the pre-recession levels.

Having said that, in the past few quarters, MGM has been able to grow its ADR by mid-single digits, primarily due to a higher convention mix. Also, the company is eyeing major events such as Rock in Rio and the Mayweather-Pacquiao boxing event, which aided the June quarter earnings. Such events boost demand for rooms and, to some extent, also MGM’s casinos on the Strip. There are many rooms available at the Strip and now that the other states are legalizing casinos, MGM has to look at its convention mix and various events that can keep the room demand intact. Having said that, MGM is also developing new casino resorts in Maryland and Springfield, Massachusetts, which will aid both its casino as well as hotel operations (read – Maryland Casino Will Fuel Domestic Gaming Growth For MGM Resorts). We currently estimate domestic hotel revenues will grow from $1.70 billion in 2014 to $2.50 billion by 2020. An estimated EBITDA margin of 47% will translate into EBITDA of $1.20 billion, representing more than 25% of the company-wide EBITDA. Since the segment value contribution is high for MGM’s stock value, incremental revenues of $300 million will translate into 10% upside to our current price estimate.

MGM’s Macau Casino Operations Will Do Well In The Long Run 

Macau gaming has been on a decline for 14 straight months, amid an economic downturn and Beijing’s anti-graft measures. However, of late, there have been a few positive signs from Beijing such as the relaxation of visa norms and a less stringent commentary on smoking ban in casinos. While it is difficult to ascertain when a recovery in gaming will kick in, we believe that the long-term Macau growth story remains intact. There are multiple factors such as key infrastructural initiatives, growth in Mainland China visitors and income levels that will drive growth in Macau. Around 70% of Macau visitors come from Mainland China and therefore a better macroeconomic environment in China is a boon for the Macau gaming industry (see – What Factors Can Drive MGM Resorts’ Stock Price?).

Also, MGM will open its new casino resort in Cotai, which will further enhance its capacity in the region. Accordingly, we currently estimate more than 25% drop in MGM China revenues for 2015. However, we expect revenues to grow from $3.5 billion in 2014 to a little under $6 billion by the end of the decade, reflecting the benefits of its Cotai property as well as higher casino volume in the coming years. An estimated EBITDA margin of 34% for MGM’s Macau operations will translate into EBITDA of close to $2 billion, reflecting over 45% of the company wide EBITDA. Again, since the segment value contribution is high for MGM’s stock value, incremental revenues of $1 billion will translate into a 10% upside to our price estimate and vice-versa.

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