It's no secret the Chinese
economy
is slowing. A multi-decade boom has perhaps given way to a new
phase of more moderate growth. Still, we're talking about what is
likely to be the fastest-growing major economy in the world. Here
in the United States, we'd be thrilled to post the 5% annual gross
domestic product growth that China is likely to generate during the
rest of this decade.
And with this solid growth comes a rising middle class, more
millionaires and more billionaires who will have more disposable
income, leading to a tidal wave of consumer spending.
So how can U.S. investors
profit
from this growth?
My favorite way is the island protectorate of Macau and its
group of casinos. These gaming venues are a virtual magnet for
China's wealthy. My favorite gaming operator in Macau:
Melco Crown Entertainment (Nasdaq: MPEL)
.
Shares
of Melco rose roughly 300%
after I recommended the stock
in September 2010. After shares were hit by profit-taking early
this year, I suggested investors again
revisit this dynamic growth story
.
The stock made a nice upward move again this past spring. But if
you missed this opportunity on those past occasions, then you've
just been given another chance. Shares have been sucked down in
this challenging
market
, and by my math, could have 100% upside if you have a 2-3-year
time horizon.
A solid take rate
Management has developed a strong record for maintaining a tight
lid on expenses, even as the company has undergone a rapid
expansion. That's helped
EBITDA
margins rise from 9% in 2008 to a recent 20%. Recent results have
also been solid. Melco has topped
earnings per share (
EPS
)
estimates by at least 25% in each of the last two quarters.
A growth lull ahead?
Shares may be pulling back in the face of a possible slowdown in
the Macau gaming sector. Revenue for all of the casinos grew just
7% from a year earlier in May, which is a sharp comedown from the
20%-plus year-over-year growth rates seen in recent
months.
In a June 19 note to clients, Merrill Lynch trimmed 2012
EPS
forecasts for this company from $0.86 to $0.83. Yet they figure
shares are still quite inexpensive, trading for just six times
enterprise value
on a 2012 EBITDA basis. That's well below the peer group average of
8.1, according to Merrill. The firm sees upside for the whole
group, especially Melco, for which it has a $20
price target
.
That's a sentiment you'll hear from other analysts as well.
Analysts at Citigroup also note the low EBITDA multiple and
consider Melco a "top pick," with a $22 price target. Analysts at
Goldman Sachs have a more modest price target of $18 (which still
represents 50% upside).
Acatalyst in place
Not only is this stock fairly inexpensive, but we may be just days
away from a news item that could boost shares. By the end of June,
Melco hopes to get the green light from the Macau government to
start building Macau Studio City (
MSC
), which I discussed in January. As I noted back then, "the casino
will be located right next to the Lotus Bridge immigration station,
making it the first and most visible casino on 'the strip.'" If and
when the company gets the official nod, then shares could score get
a quick 5% or 10% gain. Approval would also lead analysts to likely
upgrade their
earnings
forecasts for 2015 and beyond, when MSC comes on line.
Risks to Consider:
If the Chinese economy slumps really badly, then year-over-year
gaming traffic trends in Macau may turn negative, pushing this
stock below $10.
Action to Take -->
Rising levels of wealth and a cultural proclivity for gaming makes
this one of the best "China plays" out there. Shares may be choppy
in the near-term, the MSC
catalyst
notwithstanding, but look poised to make new highs in the next few
years as the company's slate of casinos becomes fully
operational.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.