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Morningstar | Melco’s 2Q Earnings Aided by Altira and Better Overseas Performance; FVE Unchanged at $22

Narrow-moat Melco Resorts reported adjusted EBITDA of $322 million in second-quarter 2018, down 15% sequentially due to weaker performance from City of Dreams Macau and Studio City. First-half adjusted EBITDA of $703 million was 14% higher year over year, accounting for 46% of our previous full-year forecast. We expect a better second-half performance on the back of stronger contribution by Morpheus and normalization of luck factor. As such, we maintain our long-term DCF-driven fair value estimate of $22 after fine-tuning our valuation model. The firm has increased its quarterly dividend by 7% to $0.14505 to reward shareholders. Nonetheless, we believe Melco is expensive, as we forecast a cyclical downturn in the Macau gaming market that will put pressure on the firm’s earnings starting in 2020.

While City of Dreams Macau’s second-quarter adjusted EBITDA was only down 2% year over year, Studio City’s adjusted EBITDA declined by 9% year over year, mainly attributable to poorer performance in the rolling chip segment (win rate of 2.7% versus 3.3% a year ago) and lower nongaming revenue, partly mitigated by higher mass-market table games drop, which increased by 23% year over year. On the other hand, Altira’s adjusted EBITDA more than tripled year over year on the back of better performance in all gaming segments, with a VIP win rate of 3.6% (versus 3.3% a year ago) and mass hold rate of 19.7% (versus 15.2% a year ago). Overall, the luck-adjusted property EBITDA margin in Macau was 27% in second-quarter 2018, versus 26% a year ago. Meanwhile, City of Dreams Manila also experienced improvement in luck factors and reported adjusted EBITDA growth of 39% year over year. In particular, VIP win rate and mass hold rate were 3.7% (versus 3.5% a year ago) and 29.4% (versus 28.5% a year ago), respectively.

We think the 770-room Morpheus, which opened in June, will be the earnings driver for City of Dreams Macau. In addition, the construction disruption on the main mass gaming floor to connect Morpheus with the rest of the property is now completed, and we should see better performance going forward. According to management, City of Dreams Macau’s mass gaming performance has seen visible improvements, with year-over-year mass drop growth accelerating from 10% in the second quarter to over 20% in month-to-date July post-World Cup and the opening of Morpheus, which is currently 100% occupied. We believe Morpheus will still have room to grow, as management expects to take another six to nine months to fully ramp up its operation. Furthermore, we understand that renovation in the VIP area of City of Dreams Macau is ongoing (will take nine months), while the renovation and refurbishment of Nuwa will be completed before the 2020 Chinese New Year. In particular, the redevelopment of the Countdown hotel will also start in the second half of 2019 and take about 18 months to complete. We think these plans will continue to help City of Dreams Macau maintain its competitiveness.

In the longer term, management mentioned that the Phase 2 expansion of Studio City is still in Melco’s growth pipeline. While this is still in the design stage, Melco is looking to begin construction in second-half 2018. Phase 2 development is close to 2.5 million square feet and is estimated to be completed in three years.