Go Where the Growth Is

Casino operator Wynn Resorts (WYNN), lead by Las Vegas icon Steve Wynn, released first quarter results on Thursday that topped analysts’ estimates thanks in large part to its exposure to Macau. Wynn reported net income of $27 million or 22 cents per share representing a strong rebound from the loss of $33.8 million from the period a year ago. Excluding one-time items the company earned 26 cents per share on revenue of $909 million both of which easily tops to the consensus analyst estimates for 14 cents of earnings on $851 million. Explosive growth in China’s Macau region continued to lead the way drawing in revenue growth of 31.6%, while the 9.3% recovery in Las Vegas also helped the company outpace expectations. Interestingly, Wynn stock actually sold off slightly in reaction to the earnings report.

Wynn Resorts owns some of the most famous and luxurious properties in Las Vegas including the Mirage and the Bellagio, but signs are pointing to further focus in the lucrative Chinese market. Recently the company pulled out of the planning stages to put a casino in the Philadelphia area, and they have also said they have no interest in owning an Atlantic City casino. On the conference call, Steve Wynn even went as far as to say the company does plan to move its headquarters to a new Macau resort set to be opened in 2014. This would be a controversial move to say the least for the gaming entrepreneur so closely tied to modern Las Vegas. However, at this point that plan is still fluid as the Macau location is in the planning stages and would not be ready for about 4 years.

We can certainly understand the appeal of focusing the most attention possible to the boundless potential of the Macau gambling region. The region already produces the majority of the company’s revenue, and it just opened their second casino in the region last week the Encore. The balance of revenue and profitability would only become more lopsided if further properties are placed in the region such as one being planned for Macau’s Cotai Strip.

Casinos in Macau are growing much faster in both gaming related revenue and non-gaming related revenue. In Las Vegas on the other hand, Wynn’s properties are seeing growth in casino operations, but food, beverage and hotel occupancy remain sluggish. Gamblers are starting to return to Las Vegas as the economy improves, but new casinos that have recently opened are diluting some of that recovery. Wynn Resort’s strategy clearly hinges on the success of their Macau operations, and so moving headquarters would allow more hands on management. Of course, there are serious risks involved whenever dealing in a country such as China where the government has the ability to sap profitability with the stroke of a pen. For instance, investors are wary of recent rumblings out of Chinese government officials calling for a cap on the number of table games in Macau. As it currently stands, the growth potential of the region is incredibly attractive, but there is always the possibility of regulatory risks.

Analysts have clearly warmed up to WYNN following the promising report out of Macau. An analyst at Macquari raised WYNN to neutral from underperform, and two others have lifted their price targets significantly. Coming into the day, the highest price target on Wall Street according to Yahoo finance was $95, but this morning UBS (UBS) lifted their target to $109 and BMO raised their target to $114. At Ockham, we downgraded WYNN to Fairly Valued as of this week’s report after many weeks at our Undervalued stance. The reason for the downgrade was simply that the stock no longer fits our definition of a value stock, even though we understand the huge potential for growth. This stock has historically traded for an exceptionally high level of price-to-cash earnings per share, which normally ranges between 40.1x and 80.0x (remember investors have always liked WYNN’s growth prospects). However, at a price above $91 per share the company would need to generate cash earnings of $1.14 per share to get back into its historically normal range. With consensus estimates calling for $.72 there is a very small chance that its historically normal price-to-cash earnings range any time soon. So, we think it is reasonable to believe WYNN shares are headed higher, but value investors may have missed their entry point.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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