As expected, MGM Resorts (MGM) bounced back with a strong quarter in 1Q17 after reporting disappointing 4Q16 results. As described in our 4Q16 update, the miss was largely driven by the shift in timing of Jewish holidays compounded by management’s miscommunication of the anticipated impact to their convention business. MGM’s management took responsibility for the error, and is clearly focused on delivering against reset expectations going forward. The fundamentals remain strong, as demonstrated by MGM’s better than expected sales and profits.
MGM bolstered our conviction in the long-term story by stating that they expect further upside in profit margins for the next few years. This is largely driven by the Profit Growth Plan, which outlines management’s cost cutting and profitability initiatives. Additional upside to profits should come as MGM’s Cotai project nears completion; the resort remains on track to open toward the end of 2017. The company is on the verge of significantly reducing capital expenditures related to new project developments, which will lead to substantial free cash flow generation. In turn, the increased free cash flow will most likely either be reinvested in a new resort in Japan or be returned to shareholders. Both outcomes would be great for MGM shareholders.
MGM’s Las Vegas properties each performed above expectations, even after adjusting for slightly elevated (i.e. lucky) hold. Hold is a term the casino industry uses to describe the profits they retain from their gambling operations. Hold typically falls within an expected range, but it is practically impossible to accurately predict the quarter-to-quarter variances within that range. Las Vegas as a whole continues to exhibit strong visitation trends, both from business groups attending conventions and individual leisure travelers. The high occupancy rates on the strip combined with rising room rates and increasing spending on food and beverages remain strong tailwinds. There is very limited supply of new rooms expected to be developed in the foreseeable future. Furthermore, Las Vegas will benefit from hosting its first two professional sports teams. The newest NHL franchise, the Vegas Golden Knights, will begin their inaugural season in the fall at the T Mobile Arena, which is partly owned by MGM and sits near several of MGM’s properties. The stadium for the Las Vegas Raiders will be built over the next few years. We expect the new teams and stadiums to disproportionately benefit MGM due to the proximity to several of MGM’s Las Vegas properties.
MGM National Harbor, the new resort in Maryland near Washington, D.C., has performed reasonably well as it ramps up operations. Further upside is expected as MGM leverages its M Life rewards program to drive consumer awareness in the surrounding areas and provide incentives for increased visitation and spending.
MGM stated that MGM Growth Properties (MGP) is looking to grow via acquisitions to diversify their revenue streams to properties not operated by MGM. MGM owns a substantial amount of MGP after splitting into two separate companies; any growth at MGP will directly benefit MGM via increased dividend payments and equity appreciation.
In total, we believe that MGM is back on track to continue producing strong results. As profitability increases and new projects come online to drive revenue growth, we expect that the stock can push back into at least the mid-$30’s.
MGM is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. MGM is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.