Based on research done during a recent visit to Las Vegas, Standard & Poor's Equity Research's fundamental outlook for the casinos and gaming industry continues to be negative.
Though the private equity boom in the sector led to significantly higher valuations, we see high debt loads compounding difficulties from economic weakness. Debt-to-EBITDA ratios for casino/gaming companies that file public financial information with the Securities & Exchange Commission rose to 7.5 in the 12 months ended June 30, 2008 from 4.5 in 2002, according to Standard & Poor's Credit Market Services, which operates independently of Standard & Poor's Equity Research Services.
With cash flows declining, debt-burdened properties need to keep occupancies high and at the same time cut costs to remain in compliance with debt covenants. However, deteriorating service levels could make that difficult, and we expect price discounting to intensify. We expect lodging revenue per available room, or RevPAR, declines of 5% to 8% in 2009, but we see those of casino hotel rooms falling more.
Little Flexibility at the Low End
At the higher end, capital requirements to fund large projects, such as those at MGM Mirage (MGM), ranked 3 STARS (hold), and Las Vegas Sands (LVS), ranked 2 STARS (sell), have led to ballooning debt levels. We see discounting exacerbated by high-end operators, including Las Vegas Sands, which have publicly committed to keep occupancies high at the expense of rates.
Operators with newer or recently refreshed properties are likely to have lower capital expenditure requirements and more flexibility in discounting, but middle and lower-market operators, hamstrung by older properties and very little product differentiation, will likely have to compete on price. We note that during our visit, a room at the high-end Bellagio was available for $160, far lower than the $250-plus rates it charged during flush times.
Over the past several years, a growing convention and corporate meeting business added to growth in Las Vegas, as did the move to attract a more upscale clientele. We estimate about 60% of 2007 revenues came from sources other than gaming. Year-to-date through September, convention attendance has fallen 3.9%, with total convention room nights occupied dropping 13.1%. With convention business more profitable and visible, we think softness in this segment will have a disproportionate economic impact.
Conspicuous Consumption is Out
We believe 2009 will continue to be challenged by a weak employment outlook, high consumer debt levels, eroding net worth from falling house and stock prices, and the baby boom generation approaching retirement age. Standard & Poor's expects the unemployment rate to rise from 6.5% in October to more than 8% in late 2009. Household debt hit a record 139% of disposable income at the end of 2007 and the savings rate fell below zero in 2006. The Standard & Poor's forecast is for the savings rate to rise to 4.2% in 2009. We expect competition to be fierce, as companies selling consumer discretionary items fight for a shrinking share of consumers' wallets.
With belt-tightening in corporate America and consumer budgets contracting, we think conspicuous consumption will fall sharply. And no destination exemplifies conspicuous consumption more than Las Vegas, in our view. Although the ultra-wealthy aren't as likely to be affected by a recession, we believe a large proportion of Las Vegas' incremental growth has been driven by aspirational customers. As those customers pull back and the wealthy restrain spending, we look for fundamentals to worsen.
A stroll through the high-end shops at Wynn Las Vegas and the Grand Canal Shoppes at the Venetian showed several stores with items 50% off, while discounting was not nearly as dramatic at middle-market malls. Purveyors of luxury goods are not immune to the downturn, as witnessed by recent announcements from Louis Vuitton—a label that prides itself on not discounting—and Christian Dior to cut prices in Japan to boost sales, and layoff announcements at Rolls-Royce and Aston Martin.
Concerns About Room Expansion
We have greater concerns about the vast majority of planned Las Vegas Strip room capacity additions that are targeted at high-end customers in the next couple of years. Additions include 2 STARS-ranked Wynn Resorts' (WYNN) Encore Suites (more than 2,000 rooms in late 2008), MGM Mirage's CityCenter (more than 6,000 rooms in late 2009), and Harrah's expansion of Caesars (more than 600 rooms in mid-2009).
However, casino companies, including MGM Mirage and Las Vegas Sands, are cutting costs to improve cash flow by eliminating layers of middle management and consolidating and centralizing shared functions. According to MGM, it has booked $225 million in annualized savings and is looking for another $150 million to $160 million in cuts in 2009. Las Vegas Sands is targeting more than $60 million to $70 million in savings in Macau and $100 million in Las Vegas.
In our opinion, MGM is several steps ahead of Las Vegas Sands in terms of cost-cutting, and we think it has more options to improve its balance sheet. MGM is looking at Las Vegas Strip and non-Strip property sales as well as pure land sales. Casino property sales are problematic in that buyers must get regulatory approval, which may not afford the best price, and challenging capital markets have resulted in a scarcity of funds to execute transactions.
Back from the Brink
Las Vegas Sands' recent $2.1 billion equity and preferred debt issuances and revision of its global development project pipeline have stabilized its financial condition for now, in our opinion, but we wonder if the company can cut its costs fast enough to offset deteriorating conditions in Las Vegas and Macau.
We think it is very vulnerable to increased competition in both markets, with Wynn's Encore opening later this month and 3 STARS-ranked Melco Crown Entertainment's (MPEL) City of Dreams casino, resort and entertainment complex on the Cotai Strip in Macau, which opens in mid-2009. Las Vegas Sands' monetization efforts hinge on the sale of noncore retail space in Macau and Singapore, which is expected to yield $1 billion to $3 billion.
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