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Morningstar | Melco's City of Dreams Macau Sees Higher Hold While City of Dreams Manila Shows Signs of Slowdown

Narrow-moat Melco's 2018 adjusted EBITDA missed our expectations by 1.7%. Luck-adjusted property EBITDA would have been $369 million in the quarter, down 2% year over year and up 11% sequentially; adjusted further for bad-debt provision, it would have been $380 million. Melco’s luck-adjusted property EBITDA margin in Macau was approximately 27% versus 29% in the fourth quarter of 2017 due to a $3 million bad-debt provision in the quarter and an $11 million bad-debt reversal in the year-ago period. Adjusting for the bad debt, the luck-adjusted property EBITDA margin in Macau would have been flat. The non-VIP segment represented over 90% of luck-adjusted EBITDA on a Macau-wide basis, which means Melco will be more resilient compared with VIP-centric competitors in the near term. Melco increased the quarterly cash dividend 7% to $0.155 per ADS and repurchased another 10 million American depositary shares for $165 million under the $500 million share-repurchase program announced last March, which is a vote of confidence in the group’s cash flow profile. We expect the same level of quarterly dividend in 2019 and 2020. We continue to see growth coming from the expansion of gaming space on the second floor of City of Dreams, upgrade of villas at Morpheus, completion of the Nuwa hotel, and upgrade of rooms and retail at Studio City. We plan to maintain our fair value estimate at $21 per share and see Melco as fairly valued.

With the help of Morpheus, City of Dreams’ mass table year-over-year revenue growth accelerated to 23% in the fourth quarter from 1% in the third quarter, as the mass hold rate increased to 33% from 28.6% in the year-ago period. Management expects to see the hold rate at City of Dreams stay in the low 30s with the addition of Morpheus, a new signature area for premium mass and dynamic management of pricing. We saw the mass hold rate increase to 32% in the first quarter and retreat to the high 20s in the second and third quarters of 2018. Therefore, we expect to see some volatility near the 30% line in hold rate in the near term. In the longer term, we believe the trajectory of higher mass hold rate is intact, supported by better traffic, longer play, and increased volume as noted by management. The new VIP facility on the second floor at City of Dreams has increased space and provided more private rooms for junkets. Five junkets have started operations, and we expect to see several more in the next few quarters. We think this will help regain some market share lost to MGM China and Sands China. In the quarter, City of Dreams’ VIP rolling was down 7% sequentially.

We are seeing more diversified nongaming offerings at Studio City such as Legend Heroes Park, an all-electric indoor theatrical stunt show, and the Flip Out trampoline park, which will open in the first half of this year. In the meantime, Studio City will cease its VIP gaming operations in January next year, and we expect the VIP tables to be redeployed at City of Dreams. Studio City will revert to a mass-oriented resort. The new phase of Studio City will include a casino, two hotel towers with 940 rooms, a 12,000-square-meter water park, and a cineplex and is expected to complete by July 2021. We have not included the expansion into our forecasts.

A further increase in rooms, amenities, and junkets and a ramp-up in the mass business at competitor Okada Manila in 2019 are expected to increase competition for City of Dreams Manila. Okada Manila, which opened at the end of 2016, expanded its capacity in hotel rooms, restaurants, VIP casino areas, and junkets and implemented a mass-market casino marketing program in 2018. City of Dreams Manila’s rolling chip volume registered 17% year-over-year and 20% sequential declines, while mass drop year-over-year growth decelerated to 4% from 18% in the third quarter. City of Dreams Manila’s luck-adjusted EBITDA increased only 4% year over year in the quarter. Adjusted for bad debt, luck-adjusted EBITDA margin was flat sequentially. This signals a slowdown in ramp-up, and we expect margin stagnation in the 2019. Okada Manila generated revenue of PHP 8,750 million ($168 million) and adjusted EBITDA of PHP 1359 million ($26 million) compared with City of Dreams Manila’s $155 million and $68 million in the quarter.