Today the market has been up and sideways basically, perhaps a little more defensive this afternoon,...
All the growth in gambling is in Asia--here's how to invest in it
03/09/2012 8:30 am EST
If you follow the sector even out of the corner of just one eye, you know that isn’t true. In 2011 Las Vegas produced $6.1 billion in gambling revenue. That’s a very poor global second to Macau’s amazing $33.5 billion in 2011 gaming revenue. The Chinese territory’s 2011 revenue exceeded the $31 billion in gaming revenue produced by the top 20 commercial casino markets in the United States.
And if you’ve really been paying attention, you know that in 2012 Las Vegas is projected to drop to the No. 3 slot behind Singapore. Singapore, which only legalized gambling in 2009, almost caught Las Vegas in 2011 with $6 billion in revenue.
If you look at the revenue growth rates for 2011, it’s hard to avoid the conclusion that the future of the gaming industry is in Asia. Macau’s 2011 revenue was up 42% from 2010. Revenue in Las Vegas grew by 5% in 2011. In 2012 revenue growth is projected to slow in Macau to between 10% and 20% and in Singapore to drop to 13%--but that’s still far ahead of the 2% to 4% growth projected for gaming revenue in Las Vegas.
The knock on the Asian gambling story is that the industry is about to be hit by a massive increase in capacity as new casino resorts in the Philippines come on line to join last year’s new gambling resorts in Cambodia and Vietnam.
I love those doubts—and the pessimists who say that growth in Macau will plunge to 14% in 2012. Those doubts are a big reason that the prices of these stocks haven’t soared into the stratosphere and out of reach. My favorite Macau stock, Sands China (1928.HK), for example, trades at just 26 times trailing 12-month earnings per share and at 19 times projected 2012 earnings when the Wall Street consensus is calling for 30.5% earnings growth in 2012.
Let’s start with the big picture and then drill down to some specific stocks, okay?
There’s no doubt that gaming companies are building casinos all over Asia. But the industry is a long, long way from overcapacity. A report from Citibank’s Citigroup Global Markets dated February 8 sees the market this way: The population of South and Central Asia is four billion and that market is currently served by just 200 licensed gambling venues. That compares to 1,600 licensed casinos in North America and 1,200 in Europe. Many of the new markets in that region are growing incredibly quickly, but from very small bases. For example, Citigroup Global markets estimates that the Philippine gaming market will grow by 17% next year—but that will still leave total revenues at just $1.7 billion. Cambodia’s gaming market will grow even faster, at a projected 19% growth in 2012, but that will leave the market with total revenue of just $260 million at the end of 2012.
The resort-oriented markets of emerging Asia have gotten most of the attention from investors, but that’s actually not the only or even the biggest opportunity. The developed economies of Japan and Taiwan don’t allow gambling at all now, and Korea has kept gambling limited to state-owned casinos. The traditional objection has been that gambling would create problems with organized crime and lead to moral decay.
But Singapore’s success in introducing casinos into a very highly regulated economy has changed thinking. In Japan, for example, a group of 150 politicians has re-introduced legislation that would legalize casinos. Gaming consultants say it will take at least 18 months to enact legislation, but they also project that the first casinos could easily generate $10 billion in their first two years. What’s that projection based on? Japan’s known appetite for gambling. The country has 12,000 pachinko halls, even though giving prizes of any sort for winning on these vertical pinball machines is illegal. (The ban is barely a legal fiction—since no prizes can be given for winning inside the pachinko hall, winners simply leave the building to go to an associated prize window to collect. Or so I’ve been told—I’ve got to be the world’s worst pachinko player. I’ve never won anything.) Japan is also home to 5 million slot machines. That’s five out of every eight slot machines in the world.
And if you’re a gaming company interested in building revenue, new casinos aren‘t exactly competition since you’re probably one of the existing companies that are building them. Las Vegas Sands (LVS), the parent company of Sands China, for example, is building a casino in Vietnam. MGM Resorts International (MGM), which owns a majority interest in MGM China, which owns the MGM Macau resort and casino, is building the MGM Ho Tram project about 80 miles from Ho Chi Minh City on a beach on the South China Sea. The resort will start with a 540-room hotel, 90 gambling tables, 1,000 slots, restaurants and bars, a conference center, and an 18-hole Greg Norman-designed golf course.
How about some specific stocks? Okay.
My favorite pure play is Sands China (1928.HK). The company, which already operates the Venetian Macau, is the only Macau casino operator scheduled to add capacity in Macau in 2012 with the opening of the Sands Cotai Central on the expanding Cotai Strip in Macau. The company expects to open 1,850 rooms initially in 20112 with the rest opening in early 2013. (The total room count is 5,800.) That opening should give Sands China a bump in 2012 when growth in Macau could slow.
If you can trade in Hong Kong, I’d suggest you take a look at other Asian pure plays in the sector such as NagaCorp (3918.HK), which operates casinos in Cambodia, and MGM China Holdings (2282.HK), which operates the MGM Macau and is beginning construction on a new resort on the Cotai Strip. If you can trade in Singapore, take a look at Genting Singapore (GENS).
If you can’t trade in Hong Kong, you can buy the U.S. traded parents of these Asian casino operations. Las Vegas is slowly recovering from the effects of the Great Recession, which hit Nevada especially hard. The unemployment rate averaged 13.5% in Nevada in 2011.So what you get with the U.S. parents of these Asian casino resort operators is a recovery in Las Vegas and spectacular growth in Asia.
For example, in 2011 MGM Resorts International (MGM) lost 23 cents a share in the fourth quarter. That was still an improvement from the loss of 29 cents a share in the fourth quarter of 2010. That loss, a result of a 57% increase in costs in the fourth quarter as the company rebuilt its computer systems to handle an upgraded loyalty program, obscured a 28% climb in net revenue from MGM China and signs that the company’s Las Vegas operation is turning around. MGM Resorts saw its revenue per available room grow by 13% in the fourth quarter and the company told analysts in its conference call that revenue per available room would grow at a mid- to high-single digit rate in 2012.
MGM Resorts is a comparative latecomer to Macau in particular and Asia in general. It’s new Cotai Strip project is designed to help it catch up with Sands China and Wynn Macau. Financing that project will depress the company’s earnings until the project starts to generate revenue.
Wynn Resorts (WYNN) got all of its $613 million in profits from Wynn Macau in 2011. The stock has bounced back recently from its drop when Steve Wynn accused Kazuo Okada, his largest shareholder and once a key ally and friend, of violating U.S. law by giving money and perks to Asian regulators in an attempt to gain casino licenses in the Philippines. I think the fight has inflicted serious long-term damage on Wynn Resorts in its efforts to expand into developed Asia. Macau is known for its lax regulation so Wynn Resorts’ success in that market doesn’t count for much in countries such as Japan that want to adopt Singapore-style regulations. And being tied to an effort to open casinos in the Philippines is another black mark since that gaming regulation in that country is considered loose even by the standards of Macao.
The problems at Wynn Resorts have helped give Las Vegas Sands an inside edge if efforts to allow casinos in Japan succeed. The company’s ability to operate in Singapore, where it runs one of the country’s two big casinos, also helps burnish that reputation.
Casinos in Japan are way off in the future—if at all—but Las Vegas Sands’ more immediate prospects don’t look any too shabby either. The company’s Las Vegas Venetian is seeing improved room rates and a pick up in convention demand. It’s Marina Bay Sands casino in Singapore is gaining share, Wall Street analysts believe, against competitor Resorts World Sentosa and retail sales at the Marina Bay Sands have ramped more quickly than expected. After starting to break out its retail results in the fourth quarter, the company looks to be positioning itself to spin off its retail real estate in Las Vegas and Macau. And, finally, the company is, as I’ve noted, the only Macau operator adding casino and hotel space in 2012.
The only thing here that gives me pause is the stock’s 26.5% run up in 2012. I don’t think the shares are terribly overvalue given the fundamental case for gambling in Asia and for Sands China in particular (Asia is the source of 85% of the company’s revenue.) But I think China’s growth rate will slow in the first half of the year until it bottoms somewhere near 7% to 8% in the second quarter before beginning to accelerate again. That could take a bite out of revenue growth in Macau and the share price at Las Vegas Sands. In addition the company is facing what is, so far, a minor investigation, into allegations that it used illegal methods to accelerate apartment sales in Macau. I think the odds that this turns into a major problem are small but not non-existent.
Given that risk I’d like a bigger spread between my December 2012 target price of $64 a share and the March 7 closing price of $54.03. A drop to $52 or so would do it. In the meantime, Las Vegas Sands goes onto my watch list. (One result of the fact that Sands China trades in Hong Kong and that market is still unfamiliar ground to developed economy investors is that Las Vegas Sands actually trades at a higher price-to-earnings ratio than Sands China at 32.5 for the trailing 12 months (versus 26 for Sands China) and 20.6 on projected 2012 earnings (versus 19 for Sands China.)
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Sands China as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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