Idea Of The Week: Can Wynn Play Through China’s Storm?

Among companies with particularly high exposure to Chinese government policies, economic growth and currency, Wynn Resorts Ltd. (WYNN.O) stands out. China has designated the peninsula community of Macau, across the Pearl River Delta from Hong Kong as the country’s only legalized gaming region. Let’s see where Wynn Resorts is laying down some bets.

Wynn has roughly 65% of revenue and 55% of segment assets in Macau. We noted last fall that an anti-corruption drive in China was affecting Wynn and other casino operations.  How is Wynn doing now? Since the market close on Aug. 10, its shares have fallen 24.5% to an Aug. 27 market close of $78.52 per share. The stock was trading at $200 per share just one year ago.

EXHIBIT 1:  Price comparison of Wynn, S&P 500 Index, and Shanghai SE Composite Index

Source: Thomson Reuters Eikon/StarMine

Perfect storm

The massive decline came at a time of growing concerns about a slowdown in China’s growth, rapid market declines and a currency devaluation that has increased the U.S. Dollar/Chinese Renminbi FX Spot Rate (CNY=) to an Aug. 26 close of 6.4038, up 3.22% from Aug. 10.  Concerns about China’s government’s stabilization strategies were accompanied by uncertainties across global emerging markets, Fed rate hikes, and falling crude oil. It all came to a head on Monday, Aug. 24, sparking massive volatility in markets across the globe.

The Shanghai SE Composite Index (.SSEC) fell 8.5% from its prior close to 3,209.910 CNY on Aug. 24 and has since declined to 3,085.4222 CNY as of the Aug. 27 close. The storm continued on to the U.S., bringing a whirl of volatility that took the S&P 500 (.SPX) down 3.9% in one day to an Aug. 24 close of 1,893.21, which has since rebounded to 1,987.66.

Everything was further fueled by an Aug. 21 pact to crack down on money laundering between The People’s Bank of China (PBOC) and the Monetary Authority of Macau followed by a raid on Aug. 26 that led to 17 arrests, according to this Reuters story.

This all rides on what has already been a difficult environment, with Chinese government visa restrictions on visitors from mainland China, a proposed ban on smoking that could have a large impact on VIP customers and government control over gaming tables.

EXHIBIT 2:  StarMine Alpha Model Indicator for WYNN

Source: Thomson Reuters Eikon/StarMine

Roulette

Filled with nine bearish indicators, four within the bottom decile, Wynn’s StarMine Alpha Model Indicator looks like a roulette table.  Additionally, three out of four of StarMine’s four credit risk models rank the company within the bottom 10% of North American companies.

It’s worth noting that Wynn scores a 3 out of a possible 100 on StarMine’s Structural Credit Risk (SCR) model, which forecasts the probability of default within 12 months, and provides an implied credit rating of B. Prior to the most recent developments in China, exposure through Wynn Macau along with the projected $4.1 billion Wynn Palace (expected to open in the first half of 2016) and uncertainties within the region led Wynn to cut their quarterly dividend to $0.50 per share in April 2015 from the prior quarter’s $1.50 per share, which had been an increase from the quarterly $1.25 per share paid in 2014.

EXHIBIT 3:  Wynn’s Quarterly Dividend History

Source: Thomson Reuters Eikon/StarMine

Cold streak

The quality of earnings has been shown repeatedly to be an important indicator; those companies whose earnings come from sustainable sources are likely to generate better financial results over the longer term. Wynn has a StarMine Earnings Quality (EQ) score of 2 on a scale of 1 to 100, with 100 representing the highest quality earnings. This score leaves the casino near the bottom decile of companies in North America, which is a bearish signal. A look into some of the model’s components helps to show some of the reason Wynn appears to be down on its luck.

EXHIBIT 4:  Wynn’s Quarterly Property Plant & Equipment

Source: Thomson Reuters Eikon/StarMine

Palace of dreams

Wynn hopes the $2.7 billion invested towards the expected $4.1 billion Wynn Palace on the Coati Strip in Macau will draw a larger crowd than Kevin Costner’s baseball field. Over the past year property, plant and equipment (PP&E) rose $1.4 billion, and increased as a percent of trailing four quarter (T4Q) average net operating assets (ANOA) by 25.5% vs. a 0.6% median increase for the hotels restaurants & leisure industry. Aside from a 5% decrease in inventories, operating assets and liabilities became less attractive and underperformed industry medians. This locates Wynn in the bottom decile of North American companies with an EQ Accrual component score of 10, well below the industry median score of 67.

EXHIBIT 5:  Wynn’ T4Q Return on Net Operating Assets & Equipment

Source: Thomson Reuters Eikon/StarMine

Efficiency roller coaster

Macau represents 55% of Wynn’s $7.4 billion regional segment total assets and 65% of the $3.0 billion T4Q revenue that declined 20.5% from the prior year, while Wynn Las Vegas saw a 0.6% decline. Macau also represented approximately 41% of last quarter’s $295 million adjusted EBITDA that fell 37% from the prior year, down 24% for the Macau regional segment and 44% for Las Vegas.

Investment in a major project within Macau along with a decline in revenue has impeded Wynn’s ability to generate revenue effectively from its operating assets.  As a result, T4Q net operating asset turnover has steadily declined over the year 0.56 to 0.84.

Declines in revenue have also hit operating profit margin (OPM) as well. T4Q adj. EBIT fell 36.3% to $903.7 million, which decreased T4Q OPM by 4.8 percentage points to 19.5%.

A look at T4Q return on ANOA (RANOA) highlights the risk management took on when they doubled down on Macau. A steep and steady decline has brought T4Q RANOA down 18 percentage points to 16.4% over the past year.

Watch and learn

The timing of political and economic forces created a challenging environment for Wynn without much clarity on the long-term effects.

While it is easy to look at Wynn and understand their exposure to China and emerging markets within the region due to their high profile projects and ongoing issues within the region, it is important to recognize many companies have similar exposure that is not as apparent, such as those that have built factories to supply a shift to a consumer economy in China.  Wynn and other casino and gaming companies within the region provide a benefit of adding some transparency to how the new turn of events could impact others.

However, this casino whale has bought in and has skin in the game. Now it will be time to watch how management strategizes and bides its time through this cold streak of luck. Wynn’s exposure to China makes it a company to watch to gain insight on how other U.S. companies may be affected by the region. They may be singing “Luck be a lady tonight.”

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