Value Investor: Crown's winning hand in Macau

The gaming and entertainment group's expansion plans indicate that capital expenditure will remain at elevated levels for an extended period.

Crown Resorts reported an impressive fiscal 2014 result, with profit after tax rising 43 per cent to $702 million. This was driven by its 33 per cent stake in Macau’s Melco Crown, which reported a 91 per cent rise in its earnings over the year.

With holdings in Melco Crown, Crown is leveraged to the emerging middle class in Asia, while its domestic market position remains very strong.

Melco Crown owns and operates two high-end properties, City of Dreams and Altira Macau, as well as Mocha clubs, the largest non-casino operator of gaming machines in Macau. The casino market in Macau is highly competitive and is growing quickly. With 35 casinos across just 31 square kilometres, it generates around seven times the gambling revenue of Las Vegas.

Crown Resort’s Australian businesses saw revenue increase slightly to $2.81 billion and normalised earnings were up 2 per cent to $803m. Crown Melbourne and Crown Perth operate in a stable environment, as they are the only licensed casinos in each city.

Crown Perth has a monopoly over the 2,500 gaming machines in Western Australia and also has an agreement that the State of WA must not grant a licence to another casino hotel of similar size and standard within 100 km. The site development is progressing well and Crown Perth is expected to open by the end of 2016.

The domestic market is mature and future growth in the company’s profits (excluding developments) will come from attracting foreign high rollers. This appears to be the trend, with VIP program play for Australian operations growing faster than main floor play since 2010 (green below).

Figure 1 – Revenue split for Crown Resorts’s Australian operations
Source: Crown Resorts

Crown’s Barangaroo development looks to set to capitalise upon growth from foreign high rollers. During the period, the company was issued a restricted gaming licence for Crown Sydney. While still subject to planning approvals and finalisation of certain agreements, Crown Sydney is expected to open in November 2019 and will contain 350 luxury rooms, VIP gaming facilities, restaurants, bars, retail outlets and conference rooms.

Meanwhile, other projects currently under development include the City of Dreams (Manila, due late 2014) and Studio City (Macau, due mid 2015).

Recent news sees two further possible developments.

In July, the gaming and entertainment group outlined a new agreement with Chinese diversified property group Greenland Holdings Group to jointly prepare a proposal to develop the Queen’s Wharf precinct in Brisbane. If successful, the joint venture will develop a six-star hotel and casino.

Crown also announced the acquisition of a vacant site in Las Vegas, which will form the basis of the company’s re-entry into the US market. Development plans for the site and the capital structure of the ownership entity are not yet finalised but Crown should have majority ownership. Total equity investment will be approximately US$400-500m, with a total project budget of approximately US$1.6-1.9bn.

These expansion plans suggest capital expenditure for Crown Resorts is likely to remain at elevated levels over the coming three to five years. As such, we suspect the dividend payout ratio will remain below 50 per cent at relatively low levels, with growth both locally and internationally being the primary focus.

The main risks are pressure on household disposable income, rising unemployment, changes to gaming taxes/levies and increasing competition in Macau.

Taking a long-term, through-the-cycle view Crown Resorts’ outlook is good. Its Australian segment operates in a mature market and holds monopoly positions in Perth and Melbourne. As the company is also well-placed to take advantage of growth in the Macau market through its investment in Melco Crown, we adopt a return on equity (ROE) of 19 per cent.

The Required Return of 11.5 per cent is low, reflecting a company with a strong competitive position and a healthy balance sheet with moderate gearing supported by steadily increasing cash flows.

Figure 2 – Crown Resort's Future Valuation
Source: StocksInValue

Distribution to Reinvestment (D-RI, red above) has an almost even split, reflecting elevated capital expenditures over the near to medium term. This contributes to double-digit intrinsic value growth (green).

We derive a fiscal 2015 valuation of $13.28.

While we view Crown as a high quality business with bright future prospects, the company is trading at a reasonable premium to intrinsic value. We would require a 10 per cent margin of safety before investing.

By Brian Soh, Equities Analyst. StocksInValue provides valuations and quality ratings of 400 ASX-listed companies and equities research, insights and macro strategy. For a no obligation FREE trial, please visit StocksInValue.com.au or call 1300 136 225.

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