MGM Resorts (NYSE:MGM) stock got hammered last week, falling almost 13%. The drop in share price follows reports that the U.S. is experiencing a second wave of the novel coronavirus, with things expected to deteriorate in the fall. The news could not have come at a worse time for MGM stock.
Las Vegas casinos recently opened after Nevada Gov. Steve Sisolak eased lockdown restrictions. MGM and other gaming companies breathed a sigh of relief, as casinos whirred back to life after months of inactivity. However, Nevada reported over 500 new Covid-19 cases on June 24, leading to fears of a resurgence. In response, MGM has said that it will make mask-wearing mandatory at all its resorts. But investors are justifiably spooked and the markets have reacted accordingly.
Meanwhile, the entertainment company possesses a highly encumbered balance sheet — far worse than that of its peers. If new lockdown restrictions come into effect, you can expect long-term debt to swell. Suspension of the company’s dividend and stock repurchase programs is also tamping investor interest. Lastly, MGM’s over-reliance on Vegas is also an Achilles’ heel that the company has been unable to overcome.
However, it’s not all doom and gloom for MGM stock, though. Shares still have an intrinsic value far north of its share price, and its asset-light strategy will also pay dividends moving forward. But shares are not a buy for me at this point.
Debt Levels are an Issue
As of March 30, total debt stood at $11.74 billion, the highest in its peer group. If that wasn’t enough, the company completed another offering in May for $750 million worth of new debt, further burdening its balance sheet. CFO Corey Sanders said the offering would provide funds for corporate purposes and shore up liquidity amidst the Covid-19 crisis.
Although MGM’s recent capital raising efforts make sense, mounting debt in an environment where revenues are drying up is not healthy. The massive debt load has much to do with MGM’s expansion policies. In 2018, the company added MGM Springfield in Massachusetts, Empire City Casino in New York, and MGM Cotai in China to its portfolio.
The casino operator remains highly concentrated in Las Vegas, so geographic diversification will always help, but it has come at the expense of MGM’s liquidity. The only silver lining is that the company has no long-term debt maturing before 2022.
Expect More Asset Sales
As I wrote in my last article, MGM is looking to pursue an asset-light strategy. In doing so, it has completed several sale and leaseback deals. I believe these deals were sound strategic moves at the time but with the current state of affairs, rental obligations linked with the deals will cost the company dearly.
To be sure, there are signs of a second Covid-19 wave in the U.S., while Asia is already experiencing it. Countries could be forced to shut down again to stop the spread. That will lead to revenues flattening, making it increasingly tougher to service debt. Such a situation could lead to further asset sales, as the company tries to drum up funds for a prolonged shutdown.
Casino’s Shares Overvalued?
Although MGM stock has made up a lot of lost ground, the stock still trades at a price-to-earnings ratio of 2.87x, as of this writing. That’s an 86.04% discount to the sector average of 20.56x.
Doing my own research, I calculated an intrinsic value of $36.54 per share for the stock. My calculations incorporated a 15% discount rate and a 10-year growth period with a terminal horizon of five years. For the growth period, I used a growth figure of 2% while I used a 3.22% figure for the terminal value — in line with the average annual inflation rate. A 56.98% margin of safety is not bad, considering the slow down we are witnessing.
However, it’s important to note here that the company is facing significant headwinds. These near-term risks can lead to higher outflows and weigh down share prices. On the other hand, there isn’t any risk of solvency and shares are trading at historical lows. A decent margin of safety and strong fundamentals are good enough reasons to increase exposure if you are in it for the long haul. If we see start to see positive headlines looking ahead, I expect the markets will be kind to gaming companies.
Bottom Line on MGM Stock
A potential second wave of Covid-19 will be a nightmare scenario for the markets in general and gaming companies in particular. Some states are reporting a spike in cases and Nevada is one of them. If we do see renewed restrictions, the pressure will mount on the company’s cash flows. The stock remains attractively valued but I would hold off on increasing my position in such an encumbered company.
MGM stock is a hold for me.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. He does not directly own the securities mentioned above.