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Morningstar | No-Moat MGM Has Several Growth Drivers on the Horizon, Shares Undervalued

While no-moat MGM's first-quarter results tracked near our 2019 sales and EBITDA growth estimates of 7% and 10%, respectively, we see a handful of drivers on the horizon (cost-cutting, improving Vegas calendar, cash flow acceleration, and Japan) for a company trading at an attractive margin of safety to our $38 valuation, which we don't plan to meaningfully change.

After its Profit Growth Plan drove $500 million in cost savings over 2015-2017 (exceeding initial targets of $300 million), MGM reiterated its goal to drive $300 million in domestic EBITDA uplift from end of 2018 through 2021, driven by labor, procumbent, sales, digital, and loyalty optimization. MGM has formed 18 center of excellence teams, or COEs, to set business strategy for specific areas (like food or gaming floor layout) across all properties, allowing for faster implementation (fewer layers) and increased ability for property managers to focus on guest engagement. We think MGM's profit target is realistic (we model around a $345 million in domestic EBITDA uplift from end of 2018 through 2021) and expect the bottom-line benefit to start in the second half of this year.

In Vegas the convention and event calendar comparisons also become easier during the second half of 2019 and through 2020, and properties like MGM Park (where renovation disruption has now passed) and Mandalay Bay (which has new convention space and sits next to the Raiders new stadium opening next year) stand to benefit.

Also, free cash flow is set to meaningfully accelerate starting this year to around $1.4 billion from $236 million in 2018, as MGM has completed the development of its Macau, Maryland, Massachusetts, and Vegas properties, allowing for leverage reduction and a growing dividend.

Further, we continue to expect MGM to win one of only two Japanese urban gaming licenses around 2021 with a resort opening in 2026, which we estimate will represent 23% of its total EBITDA that year and generates ROIC of roughly 20%.

First-quarter Las Vegas revenue and EBITDA were flat and down 10%, respectively, as tough VIP comparisons and weaker hold (MGM played unlucky) weighed. But we see these headwinds as transitory, as gaming comparisons ease moving forward, and the event calendar improves starting in the second half of 2019. Further, while VIP gaming was down, non-VIP gaming and slots saw higher volumes in the quarter (unquantified). Also, nongaming Las Vegas revenue was up 4% in the quarter for the company, supporting the view that underlying demand is healthy. Finally, we expect cost-saving initiatives to start to positively impact Vegas profitability in the second half of 2019. As a result, we don't plan any material change to our 2019 sales and EBITDA growth estimate of 2% and 5%, respectively.

In Macau, MGM gained gaming share for a third consecutive quarter, driven by its new Cotai property (opened February 2018) that has recently added new VIP gaming space. MGM saw its VIP volume grow 1% versus industry VIP gaming revenue that was down 13%, while the company's mass volume lifted 16%, near the 18% gaming revenue increase seen in the market overall. These trends are tracking near our 2019 Macau revenue growth forecast of 9.4%, which we don't plan to materially change.

Finally, MGM's regional properties preformed well, growing sales and EBITDA 3% ad 9% on a same-store basis, respectively. In particular MGM's Mississippi properties saw 9% sales growth, above our 2% estimate for 2019, driven by increased sports betting. As a result, we may slightly increase our forecast for these properties for this year, which will have an immaterial impact on our fair value estimate.