My Favorite Casino Stock Keeps Surging Higher
"Let your winners ride."
It's a favorite maxim among gamblers, and also applies to a top-performing casino stock. Recently announced monthly revenue figures from the world's newest gambling mecca implies a robust year ahead and further upside for Melco Crown Entertainment (Nasdaq: MPEL).
I laid out the investment case for this stock in September 2010, noting that Melco was the newest initiative from billionaire Stanley Ho, the legendary Hong Kong mogul that owns some of the world's top casinos.
Thanks to newfound momentum at the gaming tables of Macau, along with a series of upcoming catalysts, this stock now appears headed into the $20s, perhaps yielding 50% or more in upside from here.
Now and later
Over the course of 2012, the major players in Macau built out their hotel and casino complexes and now appear to be benefiting from critical mass. Las Vegas Sands' (NYSE: LVS) Sands Cotai Central and Venetian Macau casinos, along with Melco's City of Dreams (COD) are all on the same block in the Cotai district and now have a combined 8,000 hotel rooms. Gamblers have started to migrate to that area, thanks to its convenience to transit and hundreds of shops.
The strong traffic at Melco's COD complex likely fueled an 8% spike in revenues for the company in the fourth quarter, according to Goldman Sachs (Consensus forecasts had been anticipating flat growth in the fourth quarter). If Goldman Sachs' analysts are correct, then that would be the strongest year-over-year quarterly gain in 2012. Macau gambling revenues slowed earlier in the year on the heels of a slowing Chinese economy.
Indeed, the entire casino sector finished 2012 on a high note, with December revenues spiking nearly 20% higher than the year-ago monthly take, which should set the stage for solid 5% to 10% revenue growth in 2013 as well, according to analysts (No new casinos are slated to open, so growth will have to be on an organic basis).
With plans to spend more than $2 billion to complete those two construction projects, investors will need patience. Melco Crown likely generated more than $2 billion in free cash flow in 2012, but look for a similarly-sized free cash flow loss in 2013. Free cash flow should be modestly negative in 2014, before spiking back to 2012 levels in 2015.
With such a muddled near-term cash flow picture in place, this is a tricky stock to value. Goldman Sachs has refrained from valuing the big 2014 and 2015 casino launches, and instead focused on existing opened casinos and values this stock at $21.50 a share.
Analysts at Citigroup have a similar price target and methodology, but think that Macau Studio City will add an additional $5 in value to this stock when it opens in 2014, and the casino in the Philippines will add another $2 in value. In effect, this stock may approach $30 a share once this business model comes to fruition.
Risks to Consider: As we saw in 2012, any concerns about economic growth in China will depress valuations for Macau casino stocks as concerns rise that gambling revenues will slump.
Action to Take --> The Chinese middle class continues to expand at a solid pace, and that trend is expected to remain in place for the rest of the decade. With a strong predilection for gambling, Chinese consumers should help fuel solid multi-year gains for Melco Crown.
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StreetAuthority LLC does not hold positions in any securities mentioned in this article.