With global equity markets making fresh all-time highs, I continue to look for mispriced structural growth at a stock specific level. What I am looking for are stocks that are part of a long-term structural growth theme that are currently discounted on a well-known short-term issue.
That brings me to Crown Resorts (CWN), which has tremendous leverage to one of the great long-term structural growth themes: the Chinese outbound tourist, yet is currently being discounted due to a short-term corruption crackdown that has affected both volumes and valuations of Macau-based destination casinos.
In recent times, the Crown share price had been tracking Melco Crown Entertainment’s (MPEL) share price almost one for one. MPEL is 34.3% owned by Crown. That relationship changed last week as Crown confirmed 1H FY15 earnings that were 18% above the consensus forecast. The results showed that Crown’s diversified portfolio of assets has proven more resilient than expected, with the Australian assets, most notably Melbourne, actually benefitting from some of Macau’s short-term woes.
Earlier this week in New York, MPEL shares dropped 7.3%. There is opportunity in Crown that is being provided by MPEL weakness associated sentiment.
Quite frankly, I think we will all look back with the benefit of hindsight in a few years and realise the one chance you got to buy Crown shares cheaply was during the Macau “corruption crackdown”. It’s also occurring at a time of relatively high capex for Crown, which institutional investors with short-term performance benchmarks seem to baulk at.
The tourism trend
Let’s start at the top:
Projections are that over 200,000,000 Chinese nationals per annum will travel internationally by 2020 and they will complete over 300,000,000 “trips”. The compound average growth rate per annum is around 18%. Find another consumer sector in the world growing at 18% compound for the last five and next five years. That is structural growth and when you find a structural growth theme, you have to get maximum portfolio leverage to it.
The good news is Australia is well positioned to cater for this structural growth in outbound Chinese tourism. The recent Sydney Airport (SYD) traffic stats release confirmed that on current growth rates (16.4% in 2014), China is on track to overtake New Zealand as our strongest inbound market in 2016.
What is also little known is the Australian and Chinese governments recently agreed on bilateral air services, which immediately increases capacity from 22,500 seats per week to 26,500 seats per week between Chinese and Australian major gateways. A new category has been created between Australian major gateways and regional Chinese cities, with a further 26,500 seats capacity. Both capacity categories will grow to 33,500 by October 2016, providing 67,000 seats per week accessible from Australian Major Gateways. That’s a total annual seat capacity of 3,484,000.
This agreement on bilateral air services clearly represents the next stage of development of the Chinese inbound market into Australia and provides a significant opportunity not only for the major gateway airports (buy SYD), but also for hotel/destination casino operators tilting their product towards the Chinese inbound market.
The lower dollar
The other major macro development is just as airline capacity increases, Australia is becoming better value to Chinese tourists because of the fall in the Australian dollar. The chart below confirms that the Chinese Yuan (Renminbi) has appreciated 39% versus the Australian dollar from recent lows, making Australia now globally competitive as a tourism destination, with the advantage of being in the same time zone. This is another reason the RBA needs to cut rates again to keep the currency down and keep us globally competitive. The RBA remains behind the curve (AGB 3yr @1.86%).
The Crown interim result suggested Chinese VIP traffic is already arriving at their domestic properties, with VIP turnover play rising 61.4% to $37.1 billion in the 1H.
These results were well ahead of our estimates, with Crown Melbourne the star of the show. Crown Melbourne EBITDA rose 26.1%, while VIP program play rose 86.4%. That marquee property is really humming and now has the added regulatory certainty after the November 2014 agreement with the Victorian Commission for Gambling and Wagering that saw the Melbourne Casino Licence amended. This was a good outcome for Crown and the state of Victoria, which is already seeing Crown attract more VIP’s (VIP super tax removed).
The way I approach Crown as an investment is that the existing domestic assets and the MPEL stake underpin the current share price. The 1H numbers were a pleasant surprise in terms of domestic asset performance and give me greater confidence in the near-term valuation.
What interests me more, and where future share price appreciation will come from, is the portfolio of development assets both domestically and regionally. “If you build it they will come” is the right description. It’s that simple and patience through the capex cycle will be rewarded out the other side with a major step up in the Crown earnings base, a major diversification of the Crown asset base, and eventually a major step up in the Crown dividend base.
Crown is one of very few major Australian companies actually forgoing high short-term dividend payout ratios and investing in future GROWTH. This is exactly the right strategy and Crown shareholders will be rewarded for this large scale investment in future GROWTH over the next five years, as the assets start coming out of the ground and producing cash flows.
In response to the 1H earnings surprise, we upgraded our EPS forecasts by +8.7% in FY15, +7% in FY16 and +5.1% in FY17. Consensus now sees EPS growth for the next four years, rising to 122c in FY18.
Double digit EPS growth resumes for CWN from FY16 on. The current FY16 multiple of 15 times will prove too cheap in a broader ASX200 market where sustainable double-digit EPS growth will be hard to find.
Waving the flag
Being a supporter of Crown over the last five years had been rewarding. We are up over 100% since our initial positive view, and while the last 12 months has been choppy, driven by Macau sentiment, I remain of the view that Crown has the right long-term strategy to capture a disproportionate amount of those Chinese outbound tourist dollars both domestically and in the region.
On days like yesterday, where MPEL weakness may well see some Crown weakness, I strongly recommend accumulating Crown shares (cum 18c interim div) and holding them for the next five years when we will reap the rewards of their strategic investments.
Crown shares are relatively illiquid for their market cap due to James Packer’s 50.1% holding and that is another reason I encourage you to buy trading dips.
My whole thesis on CWN has been they are building a “luxury brand” and that the stock will be re-rated to a “luxury brand” multiple once that thesis is proven.
On that basis, I am setting a long-term price target of 20 times FY18 consensus earnings. 20x 112c =
Crown remains a high conviction buy and a core member of high conviction model portfolios.
CWN: 1YR technical downtrend broken
Go Australia, Charlie
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.