THE HEDGEYE EDGE
Melco Resorts & Entertainment’s (MLCO) Q3 was very impressive but you wouldn’t know it from the market reaction. High VIP hold was partially offset by low mass hold. On a hold-adjusted basis, numbers would have still blown away expectations. For the top line, mass trends lead the way but sustainable cost cutting really drove the quarter and should drive 2018 Street estimates higher.
The big takeaway for us is margins – cost reductions look permanent and will meaningfully boost EBITDA going forward. Our 2018 estimate goes 11% higher and is also 11% higher than the consensus, although we suspect the Street will also raise numbers soon. The multiple on our numbers is only 10-11x EV/EBITDA multiple depending on the methodology.
INTERMEDIATE TERM (TREND)
MLCO is managing costs well at its two City of Dreams properties. CFO Geoff Davis mentioned on the call that staff costs were down 8% and the company made additional cost efficiencies in marketing and technology. Davis surprised us with the comment that hold-adjusted margins at City of Dreams were 34% in Q3.
High VIP hold and a reversal in provisions benefited the property’s EBITDA by $27m and $9m, respectively. This was offset by $19m in low mass hold. Taking all those adjustments out of the equation, we get to roughly 32% for ‘normal’ margins. Still not bad, especially when considering that the property generated margins north of 30% only twice in the past 12 quarters.
Fixed costs have stabilized and are actually down YoY for CoD Macau. If they do hit 34%, then our estimates are still too low and property EBITDA for CoD Macau could surpass $1bn in 2018.
LONG TERM (TAIL)
Shares are cheap, especially considering Macau companies do not pay income taxes on gaming profits. MLCO is now trading at a 3x-4x multiple discount to LVS/WYNN/GALAXY. Some disparity is probably warranted but we do believe that gap will narrow.