By now, many investors have heard about the massive gambling mecca in the Chinese protectorate of Macau. Billions of dollars have poured into the strip, creating a similar amount of profits for investors. Yet investors may not have heard of the prologue to this story. The “Macau story” is played out: growth has sharply slowed and investment opportunities have dried up.
Or so the financial press would have you believe.
The truth is quite different. For far-sighted investors, a fresh chance at upside has emerged, especially for my favorite Macau gaming stock, Melco Crown Entertainment (Nasdaq: MPEL). A nearly 40% plunge since early March, paired with a still-robust growth outlook, means it’s time to buy.
I first looked at Melco Crown four years ago and I encourage you to read what I wrote back then before continuing. The expansion strategy laid out then exceeded my wildest expectations. Shares went on to deliver a nearly 1,000% gain.
The era of rapid growth for Macanese casinos is nearing an end. Chinese citizens -- especially the high-rollers -- are feeling more circumspect these days, especially as the Chinese government cracks down on corruption and conspicuous signs of wealth. It’s an issue for 2014, but longer-term, the Chinese economy will keep minting new millionaires. And many of them will be leaving mainland China -- where casinos are prohibited -- and hopping on the boat for Macau. In effect, think of Macau as maturing, from a phase of rapid growth to moderate growth.
Recent quarterly results gave investors a scare. Labor costs unexpectedly surged, right at a time when the casino’s hold rate diminished, which is generally attributed to good luck by gamblers. That led to a profit shortfall. Investors were also concerned about a slowdown in gaming revenues across Macau, though that now appears increasingly attributable to the World Cup. Gaming activity has picked up in recent weeks, according to management.
For its part, MPEL still has ample room for growth in Macau and elsewhere. Right now, the company is planning for the launch of a new casino complex in the Philippines, known as Belle Grande. The company is also still building a massive new complex on Macau, known as Studio City, augmenting its existing City of Dreams complex. Those new casino complexes set the stage for sales to rise from around $5 billion this year, to roughly $8 billion by 2016, according to Merrill Lynch.
While shares are out of favor, management has decided to earmark some if its cash towards a $500 million share buyback. “This is in addition to commitment to a regular quarterly dividend payout of 30% and potential for special dividends, both announced earlier this year,” said an UBS analyst.
Merrill Lynch has a $43.70 price target while UBS expects shares to reach $43. Note that both of those price targets represent more than 50% upside.
UBS extends the view of MPEL’s growth out to 2018. By then, the company is expected to generate $10.4 billion in sales, or roughly twice its 2014 sales base. And by 2018, per share profits are expected to exceed $3.50, while the dividend is expected to approach $2. That’s a 7% yield, in today’s dollars.
Risks to Consider: The greatest risk is that MPEL has not yet received a gaming license for its new Macau casino, slated to open mid-2015. The Chinese government tends to move slowly when reviewing license applications, but has ultimately approved all of the company’s previous license requests.
Action to Take --> The key takeaway for this stock is not just its growth strategy, which should yield solid revenue gains. Once the business model ripens, it's the level of profits on those sales that should really get your attention. This is a company that is in the midst of a $10 billion, decade-long capital plan, which should eventually generate more than $2 billion in annual operating profits. Don’t let the broken stock chart fool you, Melco Crown remains as one of the most compelling gaming and entertainment stocks you can buy.
Melco Crown has a solid dividend yield and is repurchasing shares... it's one step away from a phenomenal "Total Yield" score. My colleague Nathan Slaughter developed a way to find the most stable, profitable companies in the world by looking at three key metrics to produce a Total Yield. Since 1982, these dividend payers returned an average of 15% per year. Last year, this group of stocks more than doubled the S&P 500's return. To find out which companies have the best Total Yield, click here.