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MGM “Revamp” Doesn’t Make MGM Stock a Good Bet

Falling revenue and a pricey valuation make a solid bear case for the casino stock

MGM Resorts (MGM) reported better-than-expected earnings, but continued weakness in the gambling world’s most important market makes MGM stock a risky bet.

mgm stock mgm earningsCasino stocks such as MGM are suffering from a longstanding slump in China, as wealthy Chinese are no longer flooding to the industry’s hub in Macau.

Although MGM earnings showed that a pick up in Las Vegas helped offset some of that weakness, the future of the casino operator comes down to cost cuts and perhaps a restructuring or a spinoff.

That’s not to say the big rally in MGM stock wasn’t warranted. Cost cuts, restructurings and spinoffs are a legitimate way to boost earnings per share. Indeed, the market usually rewards such things. But, MGM stock remains very pricey, and the company provided no details about what its multi-year “revamp” entails.

Activist investor Land & Buildings Investment Management wanted MGM to look into spinning off its China business and converting its U.S. business into a real estate investment trust, but it called off its proxy fight in the spring.

Either move might give MGM stock a boost — at least in the short term — but it’s not clear that they would set the company up well for future growth.

Regardless, by not providing any details, MGM stock is going to move on the mere possibility of such bold moves. But, if MGM’s revamp proves to be half-hearted, Tuesday’s gain — and then some — will disappear.

Sticker Shock From MGM Stock

Regardless, MGM has to do something. The growth engine of Macau is long gone amid a crackdown in corruption, a slowing economy and a plunging Chinese stock market. MGM earnings revealed that revenue from China fell by one-third, hit by a 23% decline in table games on the main floor and a 43% hit to VIP table games.

In a bright spot, U.S. revenue increased 4%.

In total, revenue fell to $2.39 billion from $2.58 billion a year ago, which just beat Wall Street’s estimate, according to a survey by Thomson Reuters.

With revenue going in reverse, MGM profit is in decline as well, albeit not by as much as analysts feared.  MGM earnings came to $97.5 million, or 17 cents per share, up from $110 million, or 22 cents per share, in the same period a year ago. The Street expected MGM earnings of 11 cents per share.

Whatever MGM has planned, it’s going to have to be really big to justify the valuation on MGM stock. At nearly 45 times forward earnings, MGM is overpriced. That sort of valuation might have been defensible when Macau was helping the top line grow 30% annually, but that was almost four years ago. These days, analysts forecast revenue growth of less than 5% in 2016.

MGM stock is essentially flat for the year to date, and what the casino operator has planned to get earnings moving again is a matter of speculation at this point.

A spinoff, or the creation of a REIT, may sound like a good idea, but REITs aren’t doing particularly well as we head toward a hike in interest rates. And, even though getting smaller is in fashion these days, most companies are loathe to shrink themselves intentionally.

Revenue is in decline, long-term profit growth stands at 10% per year, and MGM stock costs more than twice the price of the S&P 500. Surely, there are more compelling investments to be found.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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