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Morningstar | Wynn's Near-Term Cyclical Headwinds Present Long-Term Opportunity; Shares Undervalued

Narrow-moat Wynn shares dropped around 10% after it noted a cyclical driven slowdown is impacting the higher end player in Macau (75% of EBITDA); MGM also referenced weakness during its update last week. We plan to lower our $170 valuation a mid-single-digit percentage, as we push forward our forecast Macau cyclical downturn into 2019-20 from 2020-21 (something already accounted for in our recent MGM and Sands models post their recent reports).

While near-term visibility is weakened, our conviction in Macau's long-term high-single-digit annual sales growth remains unchanged, aided by only 2% of the 1.4 billion Chinese population (two thirds of Macau visitation is from the mainland), which is seeing a growing middle-income class, having visited the gaming region (versus the 13% penetration of U.S. residents visiting the Strip). We believe our long-term view is supported by Wynn and Sands' comments that they plan to increase capital expenditure into the region over the next few years. Although it likely will require patience, we see Wynn shares presenting an attractive margin of safety for long-term investors.

Third-quarter Macau results were strong with sales up 20.5% (well ahead of the 10% gaming growth the industry reported) and $4.5 million in EBITDA per day, up from $3.9 million and $3.5 million in the prior quarter and year-ago period, respectively. But Wynn has seen a notable drop off in premium play since early October due to lower consumer confidence. As a result, it expects just $3.3-$3.7 million in EBITDA per day in the fourth quarter. We plan to drop our 2018 Wynn Macau sales growth toward 10% from 12% and EBITDA margins to around 30% from 30.8%. More impactful is our shift forward of Macau industry gaming revenue downturn. We now expect 2019, 2020, and 2021 gaming to decline 3.7% (15% increase prior), lift 3% (1% drop prior), and grow 5% (5% decline prior), respectively.

Wynn's Las Vegas resort also stands to feel impact from any slowdown in Asian premium play, as it hosts many overseas visitors. This likely contributed to the 14% sales decline during the quarter and 870 basis point contraction in the EBITDA margin to 23.9%. We plan to push forward our cyclical downturn into 2018-19 from 2020-21 in this region.

That said, the long term also looks constructive for Wynn's Las Vegas operations with limited supply set to come online and demand supported by professional sports (Raiders in 2020) and development. Las Vegas Sands discussed its plans to open a new convention center and golf course in the next 12-18 months, while designing plans for a new resort on 38 acres of recently purchased land during 2019-20. While capital outlay details have not yet been communicated, we plan to incorporate around $3 billion in development costs over the next several years yielding roughly a high-teen ROIC once fully operational in 2025. Also, Wynn sounded upbeat on Encore Boston with the resort set to open in mid-2019, offering some reassurance that the company will maintain its license post the ongoing regulatory review.