MGM Resorts International Makes for a Low-Risk Recovery Play

If you haven’t been to a large Las Vegas industry convention before, it’s a bucket list item to witness the scale and enormity of these events. Conventions are a mainstay and key economic driver for the city of Las Vegas and the casinos there. But as a result of the novel coronavirus pandemic, many have been canceled or postponed in the past year. MGM Resorts International (NYSE:MGM) is the largest casino operator in the city, and MGM stock was dramatically affected.

A photo of the MGM logo on the MGM casino building.

Source: Michael Neil Thomas / Shutterstock.com

The largest of the conventions is usually the Consumer Electronics Show (CES), which is held the second week of January each year. The 2019 event attendance exceeded 180,000 people with 4,400 companies exhibiting. The January 2021 attendance was, of course, zero. 2020 visitor attendance in Las Vegas dropped to 19 million, down from 42 million the prior year.

MGM owns or operates 29 distinct properties in the U.S. and China, including iconic brands such as Bellagio, Mandalay Bay, Luxor and MGM Grand. How these hotels and casinos recover from the Covid-19 pandemic is what will drive MGM’s results going forward. 2021 will be a partial recovery year, but if current trends hold, 2022 may be a full recovery year. Business travel is still a key part of the recovery as business travelers with expense accounts spend approximately 50% more than leisure visitors (which seems low based on my experience).

Other potential drivers for MGM stock include its Chinese locations, online sports betting, an increase in the dividend and higher returns on capital due to recent asset sales.

The China Connection

Gambling in Macau has been a growth driver for large gaming conglomerates for over a decade now. Located on the southeast coast of China, it is the only place legal gambling is allowed in the Middle Kingdom.

Annual visitors increased from approximately 800,000 to almost 4,000,000 in 2019 before dropping to zero for much of 2020. February 2021 statistics show a 173% increase in visitors, indicating a comeback is on track. It’s worth noting that substantially all that visitation comes from domestic sources. That makes sense, as international travel has not returned.

MGM operates MGM Macau and MGM Cotai in that region and has increased its market share, according to the company.

BetMGM

BetMGM is the company’s brand for digital sports betting and iGaming. It competes against other apps such as DraftKings (NASDAQ:DKNG) and Barstool Sportsbook, 36% owned by Penn National Gaming (NASDAQ:PENN).

BetMGM had a 17% market share in Q4 2020 in states where it was active. The rapid growth in digital sports betting and interactive gaming has been exhaustively well-chronicled across the investment media landscape. But based on MGM’s land-based casino marketing advantages and extensive experience in the industry, I expect BetMGM to be a leader in this space.

Dividend Increase Expected

Due to the decrease in revenues and cash flow in 2020, MGM slashed its annual dividend from $0.52 in 2019 to $0.157 in 2020. Then, it slashed it further to $0.01 in 2021. As the recovery takes hold and margins return to normal levels, I expect MGM to steadily increase its dividend. It could perhaps reach the 2019 level of $0.52 or higher by 2024.

Recent “Asset-Light” Transactions

Over the past two years, MGM has sold the Bellagio, Mandalay Bay and its namesake casino, MGM Grand, to outside investors. However, one of the purchasers is MGM itself, through a real estate investment trust (REIT) called MGM Growth Properties (NYSE:MGP).

In all three of these transactions, MGM will continue to operate the properties through a management contract and leasing arrangement. This asset-light strategy, first pioneered by Four Seasons Hotels and Marriott International (NASDAQ:MAR), provides a less capital intensive, higher return on equity business model. More importantly, the proceeds from these sales can be used to reduce debt or reinvest in the business.

Valuation of MGM Stock

Not many large-cap established companies with a recurring revenue stream see a 60% drop in revenues in any given year. But it happened to MGM and many other companies in the hospitality and travel industries in 2020. With multi-billion dollar operating losses last year, the only valuation metrics that are valid are return to recovery margins or a discounted cash flow.

Under that metric, a price target in the mid-to-high $40s range seems doable. But to keep it simple, we can just listen to legendary investor Howard Marks. He recently said on CNBC, “If you can find companies that have been penalized for their difficulties in the pandemic and the penalty was overdone and the difficulties were temporary, I think that’s a good sector right now.”

Well said. MGM stock fits that description well.

On the date of publication Tom Kerr did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Kerr, CFA is an experienced investment manager and business writer who has worked in the investment and securities business since 1994.


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