Everyone likes a fat dividend yield, especially when it comes from an established industry player in a lucrative business. With Las Vegas Sands (NYSE:LVS), that's exactly what you get: a company yielding 5.5% with operations in both Las Vegas and Asia -- and it's unarguably the market leader in the latter.
But even though the stock is up almost 20% for the year, the outlook for the company's dividend is not rosy. By relying so heavily on high rollers in Macau -- and refusing to slow the growth of the company's dividend in the face of revenue declines -- investors could be staring down the barrel of a dividend cut.
Here's what investors need to know
A reliance on Macau made the company vulnerable to declines in China
Gambling is illegal in most of China. Macau, a city right across the Pearl River Delta from Hong Kong, is an exception. Sheldon Adelson -- founder of Sands and current chairman -- saw a massive opportunity in Macau when it was handed back to the Chinese government from Portugal in 1999. Here's how important the city has been for Sands' revenue from 2006 until 2014.
But then a funny thing happened: the Chinese government started to crack down on high-rollers. Previously, junket operators arranged to have VIPs spend big bucks, much of it borrowed, in Macau. But the practice was abused, as several nefarious businesses started illegally laundering money through the VIP tables.
Thanks to the crackdown, growth didn't just slow -- it completely disappeared!
Recently, investors have been calling a bottom to Macau's troubles. And the company has been working hard to diversify its revenue streams within the city with a focus on restaurants, hotels, shows, and malls. Those are smart moves, but they won't provide immediate relief for the company's dividend problems.
About that huge dividend
Currently, Sands offers a 5.5% dividend yield. Dividends themselves are paid from free cash flow (FCF), which is what the company puts in its pocket at the end of each year, minus capital expenditures (like building new casinos). A healthy company typically doesn't use more than 85% of its FCF to pay its dividend.
Over the years, here's how Sands' dividend has stacked up.
Just three years ago, the company was only using 45% of FCF to cover its dividend. Today, it needs 146% of its FCF to pay its dividend. It is only through borrowing money that Sands has been able to continue its payout.
Where that leaves us
Obviously, this trend isn't sustainable. Sands hasn't been alone in the reversal of fortunes in Macau: Wynn Resorts (NASDAQ:WYNN) decided to reduce its dividend by two-thirds in 2015 -- although the company admittedly was in worse shape than Sands.
As a fellow Fool has pointed out, FCF is expected to increase substantially by 2018. Capital expenditures will go from $1.5 billion over the past year, primarily from building new casinos in Macau, to just $600 million by 2018.
If cash from operations reaches $4.2 billion by then -- halfway between the company's all-time high and where it sits today -- that would provide $3.6 billion for the dividend. That's not bad, but it would mean that 87% of FCF would be eaten up by today's dividend. If the company wants to keep increasing it as it has -- it's up 30% per year since it began! -- there's no way that FCF would provide enough to cover the dividend.
That leaves investors with three possible outcomes:
- FCF recovers, but not enough to support the dividend's rapid growth, and future dividend growth will be much slower.
- FCF doesn't recover enough to support the current dividend, and it is either slashed or abandoned.
- FCF recovers as business rebounds in Macau and the company can continue increasing its dividend at a hefty pace.
I think the most likely scenario is somewhere between options one and two. The long-term may end up treating Sands' shareholders very well as the importance of VIP revenue is eclipsed by sales from other sources. But if I were a dividend investor looking for steady income in retirement, I would look elsewhere to put my hard-earned cash.