Melco Resorts & Entertainment Limited

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Melco Resorts & Entertainment is a developer, owner, and operator of integrated resort facilities, primarily in Asia. The company is a large international player in the gaming and entertainment industry, but its operations are complex and subject to volatility in the current economic climate.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Melco Resorts & Entertainment Limited (MLCO) is a company that primarily develops, owns, and operates casinos and other integrated resort facilities in Asia. These resorts combine casino gaming with hotels, entertainment, retail, and dining, aiming to create a complete entertainment experience for their guests.

  • Geographic Reach: The company’s primary operations are in Macau, the Philippines, and Cyprus.

  • Gaming Segments: Melco is a major player in high-end gaming, notably through VIP gaming and premium-mass gaming, which are both highly profitable but also very volatile in nature.
  • Revenue Streams: Melco generates revenue from:
    • Casino Operations: This is the largest source of revenue, including both VIP gaming and mass-market gaming.
    • Rooms: Revenues from hotels in their integrated resorts.
    • Food & Beverage: Revenue from restaurants, bars, and other dining venues in the resorts.
    • Retail: Rent from the stores and shops at their properties
    • Other: This includes other sources of revenue such as entertainment, and ticket sales.
  • Trends in the Industry:
    • High-end gaming has come under pressure, with Chinese authorities having curbed on marketing activity for junkets. They are now more focused on premium mass.
    • Global uncertainties, and economic uncertainty, have created volatility.
    • Increased focus on non-gaming offerings, including retail, restaurants, and entertainment, which are proving to be more stable than pure gaming revenue.

  • Competitive Landscape: Melco competes with other major casino operators, including Las Vegas Sands and Wynn Resorts, in the Macau market. It also has direct competition in the Philippines and the recently opened properties in Cyprus.

    • The gaming industry is intensely competitive, with low barriers of entry. This includes new resorts, as well as established resorts.
    • Customers’ brand loyalty is generally very low, and switching costs for the customers are very small.
  • What Makes Melco Different?
    • Melco is aggressively seeking to attract the high-end Asian gambler with luxurious locations and strong customer service.
    • They are also working hard on making their resorts integrated resorts, meaning that they offer hotels, entertainment, retail, and fine dining.
    • Melco is expanding into countries outside of China, in places like the Philippines and Cyprus.
    • They have created unique partnerships, with groups like Zaha Hadid Architects, to make the resorts more innovative and attractive.

Financial Analysis

Here’s an in-depth analysis of MLCO’s financials:

  • Revenue Trends: Although Melco has seen a revenue increase of 129.6% in the last year, the growth is more modest if we look at the 5 year CAGR, only 2.8%. This shows a very high volatility in the revenue and will likely show that Melco’s growth is highly dependent on macro conditions. We also need to remember that a lot of the recent growth has come from the end of COVID and recovery, not necessarily on the strength of the business itself.
  • Margins: While the company does not report an operating margin, its EBITA margin is very large-almost 25% for their Macau and Cyprus operations. For their Philippine operations, that number is around 12%. While it is important to note that the EBITA margin has expanded by more than 20% in the last year, much of this has come from a rebound in revenue, not from the company making structural changes. It’s also important to note that the gross profit margin in Macau is around 21%, while the gross profit margin in the Philippines and Cyprus are a much higher 62.3% and 80.8% respectively. This shows how operations in the Philippine and Cyprus have a better operating leverage.

It’s important to remember that a lot of the expansion in EBITA is related to one-time nonrecurring gains.

  • Debt: Melco has large debt burdens. Total debt stands at 4.737B US dollars and total equity sits at 639M US dollars. This gives the company a debt to equity ratio of almost 7.4. However, management states they are planning to reduce leverage and deleverage the company to a target ratio of 15%, but there are no guarantees they would be able to do so.

The company has huge debt burdens that need to be paid back, however, their core business has always been dependent on debt.

  • Cash: The company reported negative operating cash flow of 140.7M US dollars for the year, which implies a cash-flow constraint as a growth company. The company has an available cash balance of 1.76B US dollars, however, this can only sustain operations and potential short-term losses until a degree.
  • Profitability
  • The net income attributable to the company stood at a negative 1.057B US dollars. However, a big reason for this is the losses that were attributable to the company because of large interest payments and one-time expenses, as the company was reorganizing after COVID. Management expects profit margins to increase in the following years, however.
  • Share repurchase and dividend: The company does not currently pay dividends or repurchase shares.

Given the ongoing economic uncertainties, the results are still quite unpredictable, and investors might find it hard to interpret the results.

It’s important to see what future growth looks like once COVID and reopening is fully over.

Moat Assessment

Based on the qualitative and quantitative analysis, here’s my assessment of Melco’s moat:

  • Moat Rating: 2 / 5

  • Justification:

    • Limited Brand Power: While Melco has a recognizable brand, it doesn’t yet possess the global brand strength or premium image compared to competitors like Las Vegas Sands and Wynn Resorts.
    • Some Customer Stickiness: Switching costs for clients are low, however, Melco has been looking to focus on the high-end gaming segment, which may have more loyal clientele.
    • Economies of Scale: Given its recent acquisitions, Melco does have a larger scale now, but it is uncertain what the structural advantage this gives.
    • Intangible assets: The resorts do have a higher cost, quality and better design, and that can be seen as an intangible advantage against competition.

Risks to the Moat and Business Resilience

  • Regulatory Risk: MLCO operates in a highly regulated industry. Changes to gaming laws and licenses in any of their operating regions can severely impact their revenue streams and operations. For example, changes in taxes, currency controls, or other regulations can heavily harm the company.
  • Economic Volatility: Economic downturns, particularly in Asia, can dramatically reduce tourism and discretionary spending, hitting the company’s revenue significantly. This has been clear after the COVID pandemic.
  • Competition: The casino and resort industry in Asia is very competitive. New entrants and expansions from competitors could dilute MLCO’s market share and pricing power.
  • Geopolitical Risks: Especially with large operations in China, government oversight and restrictions can create unpredictability and risks for the business. For example, in 2021 the government started a crackdown on Chinese nationals being marketed to by junkets for gambling. The company also faces risks from tensions with Taiwan and elsewhere in Asia, which could impact trade routes.
  • Operational Risks: Any damage to its facilities through natural disasters (or other unexpected events) may reduce their ability to generate revenue. If a facility is in a place where such events are more likely, then this may represent a substantial risk.
  • Financial Risks: Given how much debt the company has, it is susceptible to a large change in interest rates, and its ability to obtain credit facilities in the future. A sudden increase in cost of capital might make it difficult to repay those debts and further expand the business.

It’s important to keep a close eye on the political, economic, and regulatory climate, as changes to these factors can severely affect Melco’s ability to remain profitable in the long term.

  • Business Resilience: While Melco has shown resilience, it was still heavily impacted by the COVID lockdowns, and the time to recover from the low may be long. It also needs to continue finding new ways of generating revenue outside gaming (i.e. hotels, retail, and fine dining) to diversify and protect from future shocks.

Understandability Rating: 3 / 5

The overall business model is relatively straightforward as it operates primarily as a casino and integrated resort operator. However, some factors add complexity. The nature of the legal and political situations in the countries it operates in is quite complicated. It also has different business models, from VIP gaming to premium gaming. Additionally, the financial statements and capital structure are quite complex, leading to a moderate understandability of the business.

Balance Sheet Health Rating: 2 / 5

Melco’s balance sheet is quite weak. Although they have been consistently growing their business in the last 5 years, the level of debt and current low cash balance is a very large concern. The debt to equity ratio is approximately 7, while the ideal debt ratio would be near 1. Additionally, operating cash flows are negative and net profits are low. This means a high risk of potential bankruptcy or difficulty repaying loans in the future.

Conclusion: Melco Resorts & Entertainment is a company that operates in a highly volatile and competitive industry, and has seen significant issues with their operating profits and net income. Its business is highly dependent on the local economies of where its casinos are, and the current economic climate may hurt its profitability. The company’s focus on high-end gaming makes it more vulnerable to fluctuations in client behavior and macro conditions, so there is a risk involved in investing in Melco. While there have been some potential benefits shown by management in the last earnings call, these benefits will still need to be tested in the long term.