Macau Play : Melco PBL (MPEL) – on the up and worth a gamble

This article was last updated on August 23

One of the stocks I own in my portfolio is Macau (in China) casino operator Melco PBL Entertainment (MPEL). In a previous post I lamented my losses on it but believed it still had some good upside in the medium to long term. Well it had a nice run up this week ahead of its first quarter earnings report, thanks a positive review in Barron’s magazine which labelled the stock the “The Best Bet in Macau”. Here some excerpts from the article and my comments on them.

“Crown Macau started slowly, but it’s gaining share in a hotly contested arket. More recently, however, Melco’s hand has improved. It’s found ways to grab more customers, and has a huge new casino on tap. The Chinese government is now limiting new competition, aiding all the local houses. Meanwhile, shares of the Las Vegas Sands and Wynn are getting pounded by fears about a weak U.S. economy.”

As MPEL is a pure play on the Macau casino sector it is benefiting from recent local restrictions on issuing new casino licences and lack of exposure to the fragile US economy. Longer term with the regions growth potential, this stock could double in price if earning projections are met and its new casino opening (City of Dreams in ’09) meets expectations. The surrounding area and potential visitor pool for Macau is three billion people (China, India, Japan, Korea etc) and so even getting a few percentage points of market share can translate into huge revenues.

“Melco didn’t get off to a fast start. It opened Crown Macau in a remote corner called Taipa Island, where it snagged just 1% of the market, unlike the stellar performances of the local Wynn or Sands resorts. But Ho (CEO of MPEL) quickly boosted his numbers by striking a controversial deal with A-Max Holdings, a company that represents 10 junket operators that are paid commissions to bring in high rollers, or VIPs. To qualify for VIP status, a gambler must plunk down at least HK$1 million ($128,000) at the tables per visit.” Thanks to the A-Max deal, Crown Macau’s market share is now 18%. The VIP segment “is still growing rapidly,” says Ho. “There’s a lot of wealth being created in China,” he notes. For the newly wealthy, the first two travel destinations are Hong Kong and Macau. “The market won’t grow 50% forever, because Macau and China will say it’s too much. But 30% growth is more manageable,” adds Ho.

What the Analysts are saying:

Bargain hunters have begun to take note with the shares up 30% in the last month). “This is a very interesting story, and one worth beginning to start revisiting,” says Philip Ehrmann, an Asia specialist and long-term Macau skeptic at Jupiter Asset Management in London. Others say that Melco’s stock, which has risen from a low of 8.2 to 13 recently, could top its recent high of $19, about a 50% gain, and even go well beyond that in the next few years.

“He’s bringing new blood with a product strategy that’s very different from Legacy Macau, including six-star properties with non-gaming amenities and plans for mass-market visitation,” says Deutsche Bank analyst Bill Lerner. In the next few days, Melco PBL will report its first-quarter numbers. Ho won’t discuss those, but does outline the investment case: “This is a play on Asia and specifically the Chinese consumer. We have minimal exposure to a U.S. recession. Will we continue to grow? Yes.”

Joe Fath, the gaming analyst at T. Rowe Price, thinks that Melco will post Ebitda of $70 million for the first quarter, putting it well on its way to beating estimates of $100 million to $150 million for the full year. Analysts, on average, think Melco will earn 19 cents a share for ’08, 65 cents in ’09, and 95 cents in 2010. That puts the stock’s valuation at a nosebleed 68 times earnings for the current year, but just 20 times ’09. “In three years, you should get a double on this stock,” says Fath. Not a bad bet.

The fundamentals of this stock could be better (Forward PE = 18, PEG = 6) but the potential looks very promising. If you want a good, albeit risky, play for the medium to long term then this is your stock.

The full article can be found at Barrons.

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