This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Time to bet on red (China)?
No two ways about it -- last week was a lousy time to be invested in Chinese gambling stocks. In recent days, we've seen multiple analysts come out with downbeat notes on the pace of Macau table gaming revenue. Early July data shows a mere 2% increase in revenues for casinos operating on the Chinese territory, and Wells Fargo grumbles that these numbers are "3% below the year-to-date average." Macquarie warns that what we're seeing is the beginnings of an "accelerating slowdown in gaming win sales." And Citigroup draws a line -- sharply slanted down and to the right -- showing revenue growth slowing from 42% in H1 2011, to 20% in the first half of this year... to perhaps as slow as 13% for full-year 2012.

Considering this chorus of bad news so far, you have to imagine that investors cheered when on Friday, someone finally said something nice about Macau. At last, there's hope for a rebound, and it comes in the form of a new buy rating from Janney Montgomery Scott, which thinks now is a great time to pick up some cheap shares of Melco Crown Entertainment (Nasdaq: MPEL  ) .

Buy Melco? Do you feel lucky?
Arguing that shares of Melco have as much as 80% upside (an $18 price target), Janney is one of the few analysts left out there in the China fan club. But is it the right call?

Quite possibly, yes. For one thing, Melco's stock certainly looks cheap enough. Priced below 14 times earnings, the shares compare favorably to Macau rivals Wynn Resorts (Nasdaq: WYNN  ) and Las Vegas Sands (NYSE: LVS  ) , which sell for 20 and 21 times earnings, respectively. MGM Resorts' (NYSE: MGM  ) sub-2.0 P/E may look enticing, but that number is skewed by a one-time gain. Back that out, and MGM isn't looking all that cheap.

Investors who prefer to focus on actual cash production will also find a lot to like in Melco Crown Entertainment. While the most recent quarter's cash results haven't been released yet, at last report Melco was generating positive FCF at the rate of $650 million annually, which was more than twice what Melco reported for its GAAP earnings last year. Of the major Macau players, only Wynn reported stronger results than that.

Melco also boasts a balance sheet that looks considerably less leveraged than these rivals'. With less than $1 billion in net debt, the company's far-and-away best situated to weather a slowdown in gambling revenues.

Not a sure thing, but pretty darn close
Melco Crown Entertainment's superior balance sheet, strong GAAP profitability, and record of even stronger cash generation all argue in favor of Janney being right to bet on Melco. But the real kicker here is the price.

Even if you penalize the company for its modest debt, and value the stock on its enterprise value, Melco still sells for a mere 10 times annual free cash production. At this price, Melco would be cheap even if it fails to achieve the 34% long-term earnings growth target that Wall Street has set for it. Indeed, if all Melco manages to do is grow half as fast as the Street is expecting it to, the stock would still be a bargain.

Foolish final thought
Absent the Melco Crown news, the gaming sector hasn't been getting much love lately. Earlier this year, we published a report detailing how some of the smartest investors on Wall Street were sinking large sums into another embattled sector, the financials. Today, I invite you to check out our latest premium report on one of those companies, Bank of America. In it, you'll receive our top banking analyst's take on the opportunities and threats facing B of A, along with a full year of updates. Click here to learn more.

Fool contributor Rich Smith does not own, nor does he short, any company mentioned above. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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  • Report this Comment On July 16, 2012, at 11:07 PM, cp757 wrote:

    Rich Smith we poke plenty of fun at Motley Fool articles that leave out information to make a point with their endless cycle of regurgitated negative news. We get it "sharply slanted down and to the right -- showing revenue growth slowing from 42%" . We understand about the "chorus of bad news" but do they pay you by the number of negative things you can say. I can add negative words about the Melco’s Studio City project and the Manila project using up cash and adding debt but why go down that road.

    You could have said Macau is adding huge amounts of revenue on a lower percentage of growth. You did not. You could have said Las Vegas Sands will do over 12 billion dollars but that's too positive. It must be like men in a shower, the US is only going to grow at 2% so lets point out that Macau is going down to 13% but just whisper that. We could tell the reader that MPEL,WYNN,and LVS will add rooms in Macau because they only have 21,695 rooms in Macau and LVS has 34% of those for 2012. You could tell them how great it was that in 2013 LVS will have 40% of all the rooms in Macau with 23,695 rooms. You did not.

    We had another positive bit of news that LVS had approval on the extension to build 3,600 room's that will open on Lot 3 in 2016 along with Steve Wynn's 2000 room's on Cotai. Those rooms on Lot 3 are next to the The Venetian Macao that has 3,400 slot machines and 800 gambling tables with 3000 rooms . That means The Venetian would be one of the biggest building in the world with 6,400 rooms. You didn't. Your right about the Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." But you did say that.

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