Betting on This High Growth Casino

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Good investors have many things in common with smart gamblers: they both play only when and where they have an edge, they strive to find situations with an attractive risk and reward trade off, and they bet strongly when the odds are on their side. Speaking of gambling and investing, shares of Melco Crown Entertainment (NASDAQ: MPEL) look like a convenient bet for long term investors.

A pure play on chinese growth

Among US-listed casinos, Melco is the only pure play on the Chinese gambling market. Concentrated in the small region of Macau, the Chinese gambling industry has been growing at more than 30% annually over the last five years, and it’s arguably the most exciting gaming market in the world.

Macau is the world's largest gambling center; it generated $33.6 billion in revenue during 2011, more than five times the gambling revenue of the Las Vegas Strip, and it has far better growth prospects too. The long term fundamental picture for Macau looks extraordinary as its stands to profit from the rise of the Chinese middle class, and it’s still a very underpenetrated market.

The timing looks good from a short-term perspective, too, as growth could be about to rebound higher over the next months. Due to the economic slowdown in China during 2012, Macau gambling revenue rose only 14% from 2011 levels, but the year ended on a strong note with growth rates for December in the area of 20%.

Gambling activity is a discretionary expense, so it´s quite sensitive to economic growth. Now that the Chinese economy is showing renewed strength, Macau looks well positioned for higher growth rates in 2013.

When comparing revenue growth for Melco to other casinos like Las Vegas Sands (NYSE: LVS), MGM (NYSE: MGM) and Wynn Resorts (NASDAQ: WYNN), the company stands out like the high growth alternative, not only because it’s the only pure China play, but also because its smaller size makes it easier to deliver superior growth rates.

The future looks good

Although competition will be increasing in Macau over the next years, there are many strong tailwinds which should generate more than enough demand to compensate for the effects of increased competition.

Not only is Macau benefitting from secular economic trends, new infrastructure projects should benefit the region in general, and Melco in particular, in the middle term. A new ferry terminal is set to open near Melco's City of Dreams resort, new high speed railroads are reducing the travel time from China to Macau, and a 30-mile bridge between Hong Kong and Macau is expected to be finished by 2015.

Perhaps more importantly, Melco has been gaining profitability lately. The company traditionally had lower margins than competitors, but internal efficiencies and critical mass seem to be bearing good results. Melco is not only expanding its sales, but also its margins, which provides a double boost to earnings growth, and it´s a very relevant factor to watch in the middle term.

Valuation

When comparing valuation ratios for Melco, the company is trading in line with its competitors in terms of P/E ratio. However, if we include growth rates into the equation, shares of Melco look very attractively valued.

Analysts are estimating a growth rate of almost 40% annually over the next five years for Melco, which makes the PEG ratio - PE adjusted by growth expectations - the lowest in the group by a wide margin. Melco carries a PEG of 0.6 versus ratios which are more than double for competitors like Las Vegas Sands and Wynn, while MGM is currently non-profitable.

If the company is going to efficiently capitalize its growth opportunities over the next year, shares of Melco have plenty of upside potential from a valuation point of view.

Bottom Line

Melco is in the right place at the right time, and it has some very exciting growth prospects. In spite of having almost doubled in the last year, the stock doesn´t look too expensive from a valuation point of view. Improving profitability could provide a strong catalyst in the middle term, so maybe it’s time to consider betting some chips on this high growth casino.


acardenal has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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