MGM Resorts: Pent-Up Demand Likely To Translate Into Higher Profits (NYSE:MGM)

Investment Thesis

MGM Resorts International (NYSE:MGM) is a leading hospitality and gaming company with a diverse portfolio of properties, both domestically and internationally. The company has amassed over 40 million loyal customers through its Rewards program.

In addition, MGM has a long-term partnership with Marriott International (MAR), which gives MGM access to MAR’s 180 million Bonvoy rewards members. This partnership opens up a huge new opportunity for MGM to grow its customer base and drive revenue. Management said:

Replacing lower yielding room nights with Marriott room nights brings: a lower customer acquisition cost, higher ADR driven by improved product mix, and a higher quality customer

MGM Resorts International operates 18 properties between the United States and China. The company is currently seeking a license to build a resort in Japan, which management estimated the initial investment will cost $10 billion and generate roughly 20 million tourists when first built. However, for now, MGM’s main cash cows are in the United States, specifically Las Vegas and China’s Macao.

For reference, here are a few of the major MGM brand-named hotels that they operate or have partial ownership of in Las Vegas:

• MGM Grand.
• The Bellagio.
• New York New York.
• The Excalibur.
• The Aria.
• The Cosmopolitan.
• Mandalay Bay.
• The Luxor.
• And More…

Anyone who has been to Las Vegas can recognize that these properties make up at least half, if not a majority, of the Las Vegas Strip. Las Vegas is one of the most well-known cities in the United States, and it is estimated that Las Vegas sees approximately 32 million visitors each year. MGM’s wide offerings of hotels help the company offer products and accommodations for both low- and high-end customers.

The Bellagio, Mandalay Bay, and Aria are some names that offer a more luxurious hotel and stay compared to their lower-end properties like The Luxor, Excalibur, and New York-New York.

MGM offers something for everyone and has done a great job renovating and maintaining its properties. Most recently, they announced that they have reduced the average age of their portfolio by two years. With new resort properties springing up in Las Vegas and around the world, it is important that MGM remains disciplined in improving its properties and offerings.

One of the newer and faster-growing parts of MGM’s business is BetMGM. Through their app, they now offer sports betting and their iGaming brand in 26 North American jurisdictions and 9 areas across Europe and Canada. MGM remains the leader in U.S. iGaming by utilizing both its hotel properties and growing online presence.

MGM’s properties give the company an advantage over its peers. However, one area where MGM has been lagging and can still see improvement is in online sports betting. FanDuel and DraftKings (DKNG) are the market leaders and are close to holding a duopoly over the industry. MGM is currently the third-largest player in the online sports betting market, but I believe they have room to grow due to their brand reputation and offerings they can add into the app.

MGM’s ability to possibly tie online sports betting in its app to its rewards program gives it an advantage that DKNG and FanDuel could not offer. I believe that with more advertising and marketing spending, and strategic integration of the two, BetMGM could steal market share from the leaders.

Overall, I believe MGM is the leader in gaming entertainment and will continue to make decisions that keep them ahead of the competition. Their diverse offerings of properties, paired with their rewards program and online sports betting (BetMGM), will allow them to continue to grow.

The stock is up just over 31% year-to-date (YTD) as of August 31, and I see the 13% pullback in August as a great opportunity to start a position in the stock. MGM’s properties will generate cash flows in the long term, and their new offerings will help attract and retain customers, growing brand popularity and the business as a whole.

Balance Sheet & Profitability

It is very important for MGM to maintain a clean and well-managed balance sheet, given its industry and the ways the company invests internally to spark growth. Building new resorts and hotels across the world is expensive and capital-intensive. Fortunately, MGM’s management has positioned the company well to continue generating cash from its current offerings and investing in new ones.

At the end of Q2, MGM reported that it had a total of $5.5 billion in liquid funds and $2 billion in excess cash. Having adequate cash and funds available gives MGM the financial flexibility to pursue its growth plans, whether it is investing in new properties, expanding its online sports betting business, or returning capital to shareholders.

Although cash flows and profitability are starting to recover from the COVID-19 pandemic, the devastating impact of the pandemic had a significant influence on the entertainment industry. MGM was forced to close its casinos and theaters for months, leading to a significant loss of revenue. This forced the company to finance operations through debt.

MGM ended 2019 with $15.6 billion in debt. By March 2020, debt had already risen to $20.5 billion. Debt peaked at $34.08 billion at the end of 2022, but has since declined to $32.04 billion as the company has begun to address its rising debt and paid some off. Revenue and foot traffic are starting to return to pre-pandemic levels. This helps ease management and investors nerves as money is coming in quicker to help pay off debt. It was stated that Macau casino revenue hit its post-pandemic high despite economic headwinds in China

Now that everything is reopened, I believe tailwinds will continue to push the stock higher over the next few years. Pent-up demand for travel, entertainment, and casino gambling will take a few years to die down, which will allow the company to rebuild its cash pile and hopefully pay off the excess debt it took on over the past 3 years.

The rising amount of debt in the past few years has caused the company’s net income margin to contract significantly. Gross profit and operating margins have both steadily increased in the past few years and are both well above their 5-year average and the sector median. However, net income margins are currently 2.54%, which is less than half of the 5-year average of 6.75%.

This is all due to the pandemic and its impact on the company. As MGM had to take on more debt, interest expense also grew, lowering net income margins. The company had to cut back on spending and operational costs to improve GP and OP margins in order to offset the decrease on the bottom line.

Earnings per share (EPS) was $0.77 in 2019. In 2020, they bottomed out at negative -$3.94. The company was losing money left and right because they simply could not open their doors. Thankfully, they are back on track and looking to become more profitable than ever. Analysts are expecting 2023 EPS to come in at $2.42, the highest ever for MGM.

MGM has generated positive free cash flow (FCF) for every year since 2017, except for 2020, which was due to the COVID-19 pandemic. The company currently has $1.18 billion in FCF, which would give it a 7.66% FCF yield. This is very strong for the industry. I typically look for a FCF yield of 8% or higher in stocks that suggest a strong cash flow, so I would round up and include MGM’s FCF yield when talking about impressive cash generation.

Current cash from operations (CFO) is already higher than 2019 levels, showing how the company’s cost-cutting decisions from 2020-2022 are now resulting in higher margins and cash flow as pent-up demand starts to turn into cash spent and trip taking.

MGM had a tough few years due to the pandemic, but that was an anomaly. Things like that don’t happen often, and MGM’s management handled it well. They had no choice but to take on debt to fund operations from lost revenue. However, management knew that the pandemic would not last forever and that the reopening would happen someday. They continued to expand, grow brand presence through its app and online betting, and came out of the pandemic stronger than ever.

Now that MGM is operating at full throttle, it will be a steady moneymaker. The company will use its earnings to fund new projects for growth and look for different ways to return capital to shareholders.

Valuation & Price Targets

MGM is currently trading at 18.2x 2023 price-to-earnings (P/E) and 15.5x 2024 earnings. If you look at MGM’s historic P/E chart, it is heavily skewed and unreliable because of the impact COVID had on its earnings. That is why I looked at the company’s average P/E three years prior to the pandemic, from January 2016 to November 2019. The company’s average P/E in that time was 24.4x earnings. This does seem expensive, given the sector median of 15.1x and the company’s slow growth rates, which tend to be in the mid-to-high single digits. However, it is important to remember that MGM has industry-leading margins and profitability, which results in higher valuations when compared to peers.

I have attached my price target scenario table below. I use current valuations and 2024 analyst estimates to create a bull, base, and bear case price target for the next twelve months (NTM). I use the company’s historic valuations and a $0.15 EPS buffer to create the price target ranges. At $44 per share, MGM currently trades at an enticing 3.8x risk-to-reward (R:R) based on my calculations. I typically look for R:R greater than 3x when entering a position. This helps to support my case that investors should consider entering MGM given its recent pullback. My base case fair value price target shows that MGM is trading at a roughly 15% discount at current prices, as shown below.

MGM is currently trading towards the lower end of its price target range. I believe this is a good opportunity for investors to buy before the next leg up. Using the Fibonacci retracement tool, we can see that the stock has bounced off its support and is now looking to move up. Resistance is currently at $45.36. We could see consolidation between $41 and $45 per share before a break higher, given good news or a strong catalyst.

Risk

The main risk when assessing MGM is the risk of another pandemic, whether it is another COVID outbreak or a new disease. This is a worst-case scenario, but it is a real possibility. MGM was forced to completely stop operating for months during the COVID-19 pandemic. Out of MGM’s estimated $16 billion in revenue this year, only $1.8-$2.0 Billion will come from its app and online sports betting platform, BetMGM. This shows how much of a hit revenue would take if the doors were to shut again, as almost 90% of revenue comes from its properties and casinos being open. The growth of its app and services away from its properties could be a key driver of growth and diversification that the company needs to mitigate risk.

In addition, MGM has a lot of exposure to China because of its one-of-a-kind resorts in Macau and Cotai. China has a strict zero-tolerance policy for COVID-19, and it will completely shut down a town, city, or even the entire country to prevent the spread of the disease. The Chinese government closely monitors MGM’s operations in China. In 2021, it was reported that the central government controls the number of gaming tables, labor for development projects, and visas for Chinese visits to Macau. It also announced plans for heightened supervision of casinos.

China’s heavy-handed control could lead to a quicker and longer shutdown of MGM’s operations in China than in the United States. The margins and cash flow are better in MGM’s Chinese operations, so another shutdown could drastically hurt the stock… Again! However, as investors, we should be prepared for news like this after what happened in 2019-2020. We should not be overexposed to MGM and should diversify our portfolios so that we are prepared if another pandemic occurs.

The last risk I want to mention is the competition that MGM faces. Competitors will have a hard time competing with MGM’s property portfolio, but they could replicate and compete with it in the gaming industry, specifically in online gambling. First, when it comes to online sports betting, DKNG and FanDuel easily dominate the market. Together, they could squeeze out or minimize MGM’s footprint in this industry segment.

Additionally, I think more companies like these two, or other competitors, could enter the industry and start finding new ways for people to gamble easily online from home. People love to gamble, approximately 4.2 billion people gamble at least once a year. I believe companies will capitalize on society’s love of gambling and laziness by creating easier ways for people to gamble online at home instead of going to the casino. I believe this is a catalyst to watch and could potentially hurt MGM’s business model if it does not continue to adapt and evolve its app and online presence.

Conclusion

MGM is rebounding well after the pandemic. They did everything they needed to stay up and running during COVID-19, and are now reaping the benefits of pent-up demand. MGM’s diverse property portfolio differentiates them from their competitors and offers all types of customers everything they need. They have a strong rewards program and a new, strong partnership with Marriott that opens the door to 180 million new customers. They dominate the Las Vegas Strip and have two of the few hotel resorts and casinos in all of China.

They have added more debt to their balance sheet than I would like to see, but it was for a good reason. The business generates a lot of cash, and with higher top-line margins and improving net income margins, I believe they will continue to generate cash and pay off debt. They have done a good job adjusting and growing their online presence, and I hope to see them advertise and market it more. I think a key strategy for management should be incorporating their loyalty rewards program and BetMGM. Growing their online presence along with continuing to build new resorts around the world will reward investors. Use MGM’s pullback to the low $40s in the last month as an opportunity to start a position or to add more.