Wynn's Iconic Image Reflected in Its Narrow Economic Moat
The resort and casino is well-positioned to reap benefits of Macau's future infrastructure development.
We continue to think that Wynn Resorts' (WYNN) narrow moat is well intact, driven by an iconic brand that should see its room share in the attractive Macau market (where there are only six gaming licenses) expand to 9% from 6% with the opening of Palace on Aug. 22. We are encouraged that the new resort is already 70% booked for the first five weeks, with even higher levels of occupancy for the Golden Week holiday in October. That said, we do plan to reduce our near-term Macau forecast to account for our updated view that industry gaming revenue will grow at a more modest pace than previously expected due to the city’s capacity constraints that will hold back visitation until key infrastructure comes on line starting in 2018. As a result, we plan to lower Wynn's average annual Macau sales growth to 8% from 9% previously over the next decade, while continuing to expect margin expansion to the low-30% level in 2025 from 29% in 2015, driven by a higher mass- and nongaming mix, resulting in our $136 fair value estimate being reduced to $125, leaving shares undervalued. Our intermediate-term view on Macau remains constructive and is in fact strengthened by the positive and sustainable impact we expect many key developments will have on the destination’s brand and growth, which will be supported by strong China outbound travel.
We expect Macau's capacity to expand to 46.5 million visitors by 2025 from 2015's 33.2 million, or up 37%. This expansion is led by four key infrastructure projects--light-rail transit, Pac On Ferry Terminal, Lotus Checkpoint expansion, and reclaimed land--that we expect to alleviate the region's crowded street traffic (main bottleneck to expanding capacity). We also see other projects lifting accessibility to Macau, thereby improving the city's brand and driving visitation to 45.6 million in 2025 from 30.7 million in 2015, or up 49%, allowing for average mid-single-digit annual gaming sales growth over the next 10 years.
Macau's Infrastructure Improvements a Good Bet for Wynn
We view Wynn Resorts as a high-end iconic brand that is well-positioned to participate in the attractive long-term growth opportunity of Macau (60% of EBITDA) as it expands its room share to 9% from 6% through the Cotai Palace opening in August 2016. The offset to this expanded room presence is the continued shift away from VIP and gaming revenue (where Wynn has outsize exposure) toward nongaming and mass play, as well as its existing Macau property being located on the peninsula, where traffic has lagged Cotai.
While we expect Macau's visitation and gaming growth to increase in 2016 and 2017 as new casinos open, we expect improvement to be gradual. We expect an acceleration in growth to start in 2018 as key infrastructure projects that alleviate Macau's congested traffic (Lotus checkpoint and Pac On Terminal in 2018, light-rail transit in 2019, and reclaimed land in 2020-25) come on line, which will expand the region's constrained carrying capacity, thereby driving higher visitation levels. Our forecast for annual mid-single-digit visitation growth over the next decade is supported by China outbound travel that we expect will average high-single-digit annual growth over the next 10 years. Additionally, we expect upcoming developments that add attractions and improve Macau's accessibility will improve the destination's brand, further supporting our constructive long-term view on Macau. With Wynn holding one of only six gaming licenses, it stands to benefit from this growth. That said, the Macau market is highly regulated, and as a result the pace and timing of growth is at the discretion of the government.
Las Vegas doesn't offer the long-term growth potential or regulatory barriers of Macau, so we do not believe the region contributes to Wynn's moat. But there have been very minimal industry supply additions this decade, which is expected to continue until mid-2018 when World Resort is set to open and add mid-single-digit incremental supply to the region, offering support for industry Strip occupancy around 90%.
Wynn's Boston property, Everett, opens in 2019, providing incremental growth that year.
Macau Licensing Creates Barriers to Entry for New Competition
We think Wynn Resorts has a narrow moat driven by its established brand and gaming concession intangible assets in Macau. Wynn is synonymous with high quality, and its Macau property is the only resort in the world with seven Forbes five-star awards. Its past success with Bellagio and Mirage in Las Vegas aided the company in winning a gaming license in Macau, where government regulation creates meaningful barriers of entry for new competition. Further, this continued success in Macau helped Wynn win the only gaming concession awarded in the Boston market, where the company plans to open a resort in 2019. This continued execution of building and operating some of the best integrated resorts in the world positions Wynn Resorts to win concessions in any future gaming markets (Japan, South Korea).
In Macau (60% of EBITDA) there are only six gaming licenses, which are not up for renewal until March 31, 2020 (for SJM and MGM (MGM)) and June 26, 2022 (for Wynn, Las Vegas Sands (LVS), Galaxy, and Melco (MPEL)). We believe these concessions are likely to be renewed or extended for these operators as they have invested meaningful capital and helped positively develop the Macau economy. Given the limited land available to develop and the government's seeming preference to control growth of the region, we also think it is likely that there are not any meaningful new gaming concessions or table allocations presented at the time of renewal. As a result, we see a continued controlled limited supply of competition for the Macau market over the next decade, supporting our narrow moat rating.
The Wynn Macau is located on the Macau peninsula and not on the Cotai Strip, where the mix of traffic has migrated. That said, Wynn expects to open its Cotai Palace property in August 2016, which will increase its room share to 9% from 6% among the six concessionaires once the upcoming industry supply increase is complete in 2017. Wynn’s Macau room count then may increase another 1,500 rooms by 2018-19 with the second phase of the Cotai Palace, which would bring the total room count to 4,200.
We see the Las Vegas region (40% of EBITDA) as not having a moat due to lower regulatory barriers that increase competition, leading to lower returns on invested capital. Although the region does not contribute to Wynn's competitive advantages, it is encouraging that current supply and demand is better now than a few years ago. After 79% and 24% room supply growth in Las Vegas during the 1990s and the first decade of this millennium, respectively, room supply has increased just 1% through 2015, and the outlook is for no meaningful supply additions on the Strip until mid-2018 when World Resorts is set to open (a Genting property), which should help sustain Las Vegas Strip industry occupancy at healthy levels of 90%. Additionally, the large number of resorts and composition of Las Vegas (60% nongaming and 40% gaming) support relatively healthy and consistent visitation (repeat visits with plenty to do and see) that cannot be replicated by the U.S. regional market. That said, we believe regional casinos will continue to place competitive pressure on Las Vegas' gaming business, resulting in low ROIC.
Wynn's consolidated ROIC and operating margin expansion offer quantitative support of our narrow moat rating. We believe ROICs will decline to still-healthy low-double-digit levels in 2016 and 2017 as regulatory headwinds and carrying capacity constraints continue to weigh, offset by falling capital expenditures levels post the Wynn Palace opening in 2016 and start of construction on the Boston property in 2016 and 2017, which will lead to 19% ROIC in 2020, a level comfortably ahead of the firm's 7.7% cost of capital. Additionally, operating margins are modeled to reach 24% in 2025 from trough levels of 16% in 2015, aided by a rebound in growth and mix shift to higher-margin premium mass- and nongaming in the Macau market.
Government control prevents us from considering a wide economic moat. While unlikely, the Macau/Chinese government could award additional gaming licenses that would increase market competition. In an extremely unlikely scenario, the Macau and Chinese government could exercise its right to seize and take control of all operations on the island, which would meaningfully affect the economic profit outlook of Wynn Resorts.
Smoking Ban, Junket Regulations Pose Some Risk
The principal risk to prospective shareholders is a downturn in Macau, either macroeconomic or through government regulation. In 2015, the firm derived around 35% of total revenue from Macau VIP players, a segment that is sensitive to economic, housing, stock market, and credit market conditions. VIP rolling chip volume in Macau faced a double-digit decrease in the first half of 2009 amid the credit crisis and a steep decline in the Chinese stock market, and it has showed renewed weakness due to anti-corruption activities in China during the past several months, as well as renewed concerns of slowing economic growth and currency devaluation.
The central government controls the number of gaming tables, labor for development projects, and visas for Chinese visits to Macau, and it may implement a full smoking ban that will have an outsize impact on VIP revenue (VIP rooms allow smoking). Also, the Macau gaming board said in 2015 that it may require more disclosure on deposits made by investors into the junket system; if it caps deposits, that would likely pressure VIP volume. Finally, mainland Chinese mass gamers often pay for goods using credit at pawnshops and return them for gambling money; should these transactions be regulated, it would likely add pressure to mass gaming volume.
A long-term risk is the potential for increased competition from new integrated resorts in other Asian countries and any expansion in Macau gaming licenses.
The Las Vegas Strip is highly cyclical and depends on business travel and personal travel expenditures. During the last recession in the U.S., gaming revenue there declined 19%.
Additional risks include the chance that something could happen to founder Steve Wynn and the risk of damage to the Wynn brand name. Kazuo Okada continues to appeal Wynn's forcible redemption of his shares in 2012 (which represented approximately 20% of shares outstanding), and there is some risk of the redemption being reversed by a court ruling.
Dan Wasiolek does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.