Investors may not want to hear this, but MGM Resorts (NYSE:MGM) may barely have enough liquidity to survive. In any case, MGM stock is going to take a hit from here. It is already down one third from its recent closing high of $23.76 in early June. I think it is possible the stock could get close to is previous lows.
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That’s because the company reported very dire second-quarter earnings this past week. In fact, MGM did not produce either a burn rate figure for the quarter or a cash flow statement.
But one thing is clear: MGM lost $1.2 billion in operating income before taxes in the quarter. I suspect that its actual free cash flow was at least one-third worse than this, or $1.6 billion.
The problem is MGM has just $4.8 billion in cash and equivalents on hand. That means for all practical purposes, MGM has just three quarters of cash burn if its operational losses stay as bad as in Q2.
Everything Hinges On a Vaccine
Barron’s came out with a story recently about a poll done by Macquarie Research and Survey Monkey. The researchers asked 417 people over 21 on whether they would visit Las Vegas if there was no vaccine available yet. The report was that 65% of the people responded “no.”
In other words, MGM’s revenue and cash flow will not improve until a vaccine is widely available. And sure, it’s possible there could be a vaccine breakthrough by the end of this year. But if people are not comfortable that the vaccine is widely available, they may not travel to Las Vegas. In addition, conventions may not pick up until the second or third quarter.
That uses up most of the three quarters of liquidity. However, that assumes that cash burn is as bad as in Q2. That is not likely to be the case. In other words, I think even pre-vaccine, more people will start to gamble and visit Las Vegas, lowering the quarterly burn.
Moreover, MGM claims it has up to $8.1 in total available liquidity, not just the $4.8 billion on its balance sheet right now. That means the company would have to take on further debt, but the option is there.
What Will Happen With MGM Stock
Let’s say that the company does not raise further debt or equity during Q3 and Q4. That could reduce its cash balance by at least 50%. The MGM stock price will not stay where it is now. It will be much lower. That will be the case even if a vaccine is right around the corner.
The reason is twofold. One, the lower cash balance will introduce further risk to equity holders. Some investors will fear that the company will run out of cash, even though that fear might be irrational.
For example, as I pointed out, the availability of up to $8.1 billion in total liquidity should allay that fear. But the investing public is not always that rational.
Second, even if the company takes on additional debt, that also reduces the company’s balance sheet strength and introduces more risk. Again MGM stock will trend lower as a result.
And third, as I pointed out above, the company’s losses are going to continue until a vaccine is widely available. In other words, people will delay traveling to Las Vegas unless they know that if they pick up Covid-19 they can get cured from it.
So, I suspect that the MGM stock is looking at another downturn of at least 20% to 30%.
What to Do With MGM Stock
If you are a contrarian, can invest for the long term and are willing to dollar-cost average into MGM stock at lower stock prices, there is good upside. For example, at the end of Q2 2019, the company produced $568 million in operating cash flow. That is $2.27 billion in operating cash flow annually.
Using that number and applying a 10% yield, the market value would be $22.7 billion. Since MGM has 493 million shares outstanding, that puts the potential target price at $46 per share. That represents a potential gain of 351% over today’s price.
Let’s say that takes three to four years to happen at the most. The average annual return would be 37% to 52% annually over three to four years.
So that is the potential upside case. The problem is the company is calling it close. They should have enough liquidity to survive, assuming there are no surprises in the wide availability of a Covid-19 vaccine. But the stock will likely take a dip first before that is apparent.
So, take your choice. Invest for the long-term and average down. Or wait until things are more clear, and then take a position. Either way, there is money to be made here with MGM stock. The company is likely to survive. The stock will just face a bumpy road first.
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