MGM Resorts: An Evaluation Of Short and Long-Term Prospects

If investing was as easy as identifying the next company that is going to reopen for business after being forced to shut down for a few weeks, there would be not one, but many Warren Buffetts out there. Unfortunately, investing in the stock market is a much more complex task and the ones who spend hours on mastering the game are in a better position to generate attractive returns in the long run. This brings us to MGM Resorts International (MGM). The overarching “investment thesis” that we found on stock discussion forums is:

MGM stock will skyrocket because casinos are set to reopen once again following the easing of mobility restrictions.

You might argue that there is some truth to this so-called thesis. Beat Billions agrees. However, we invite investors to differentiate between a piece of news and a thesis for an investment in a small-cap stock. We believe that the reopening of the casinos is a piece of news that will temporarily balloon the share price of MGM, but this should not be mistaken for an investment thesis that could permanently lift he market value of the company.

Beat Billions‘ thesis for MGM stock is fairly obvious: make hay while the sun is still shining, but know that the sun won’t shine for long.

Don’t be fooled by the last year EPS

Beat Billions is committed to reading between the lines and digging information for our readers who are focused on generating alpha returns by trading/investing in small-cap stocks. While we do not provide any sort of investment advice (because we are not licensed to operate as such), we bring unpopular and uncovered information to the table and believe such data will improve the decision-making process of investors. When it comes to MGM, it’s in the last year’s EPS that we uncovered some truth that does not meet the eye of most investors.

For 2019, MGM Resorts reported a net income of $2.04 billion that translated into an EPS of $3.90. This looks good on the paper because the company only earned $0.82 per share in the previous year. But, there’s a caveat.

In 2019, MGM sold Bellagio Casino to the Blackstone Group for a total consideration of over $4 billion and then leased back the assets from Blackstone. This might prove to be a good strategic move in the long run as the casino industry is moving to become a land-free industry. MGM reported a gain of $2.67 billion from this transaction, which, by all means, is a non-recurring transaction.

Source – Form 10-K

**When reading the above data, please note that the gain is listed as a negative number as this is classified under the “expenses” heading. In this segment, positive line items indicate an outflow whereas a negative number indicates an inflow.

If we exclude this transaction, the 2019 EPS would come to ($0.8). Yes, in the absence of the gain reported from the Bellagio sale, MGM Resorts would have reported negative earnings for 2019.

Investors need to take this into account before claiming that shares are trading at very attractive earnings multiples, when, in fact, the P/E would have been a thumping ZERO if we correctly account for the non-recurring item on the 2019 income statement.

What MGM couldn’t do for the last 3 years, it might not do in the next 3 years

There’s a lot of hype about the reopening of the economy and how MGM Resorts stock would benefit from such action. Before we think about the future, however, we can get an idea of what to expect by examining the historical performance of the company.

Both revenue and earnings grew at lackluster rates in the last 3 years, and the performance of the share price is a testament to this not-so-attractive financial performance of the company.

Source – YCharts

As depicted in the above illustration, MGM stock has gained just 8.75% in the 3 years ended on February 1, 2020, underperforming the broad market by a considerable margin.

The question is, is there reason to believe that things will reverse in the next 3 years? And the answer is, the future looks more difficult than what it was in the last few years.

Don’t expect MGM Resorts to operate in full flow once reopened

Going by the reaction of investors, it seems as if the majority is expecting MGM Resorts to get back to its normalcy as soon as its business is open for customers. Beat Billions, however, disagrees.

Going by the recent remarks of World Health Organization representatives, social distancing rules are likely to remain in place until mid-2022. Even if we treat this as a worst-case scenario, it’s reasonable to expect some sort of social distancing policies to remain intact until mid-2021. Casinos, bars, and restaurants will not be allowed to operate at maximum capacity, leading to loss of revenue that extends for more than 12 months. This is not good news for MGM Resorts.

Next, the recession will lead to a decline in gambling activities as well. This is another thing many investors are not factoring into their analysis of MGM stock. A research conducted by the Journal of Gambling Studies, in 2011, found out that lottery consumption is the only form of gambling activity that is recession-proof. The below is an excerpt from this research document that you can find here.

Empirical results are obtained using monthly aggregated US per capita consumption time series for the period 1959.01–2010.08. Among the three gambling activities only lottery consumption appears to be recession-proof. This series is characterized by a vast and solid growth that exceeds the growth in income and the growth in other gambling sectors. Casino gambling expenditures show a positive growth during expansions and no growth during recessions. Hence, the loss in income during recessions affects casino gambling. However, income shocks which are not directly related to the business cycle do not influence casino gambling expenditures. Pari-mutuel wagering displays an overall negative trend and its average growth rate is smaller than the growth in income, especially during recessions.

Finally, it’s reasonable to assume that consumers will take time to leave the scars created by Covid-19 behind. There is a risk of a second wave of infections as well, similar to what happened during the Spanish Flu outbreak of 1918.

Taking all these factors into consideration, Beat Billions believes that the next 3 years will prove to be a difficult time to navigate for MGM Resorts and other casino companies.

Takeaway: Sentiment will rule for now but earnings will once again dictate terms in the long-term

We are long-term investors in equity markets. But, that does not limit us from analyzing “hot stocks” that are making moves in the market. While we agree that MGM stock price will be favorably impacted by the eventual reopening of the casinos, the party will likely not last long. We expect a deterioration of the positive sentiment toward MGM in the next few weeks as well, when investors realize that MGM would not be allowed to operate at the maximum occupancy level. In the long-term, MGM shares will come under pressure from lackluster earnings growth. Based on these two fronts, we refrain from investing in MGM stock at the current price levels.

A short-term oriented trader might disagree, saying that the positive sentiment in the market will push shares higher as the reopening approaches. That, we agree. However, we refrain from investing in MGM stock based on its long-term prospects and the expected deterioration of the investor sentiment in the next few weeks.

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Come back tomorrow to see our next small-cap pick before the market opens!

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