Casino stocks with exposure to Macau have all had a hot start to 2019 as optimism about the region's gambling market improves. It's been a rocky road, but Las Vegas Sands (NYSE:LVS), Wynn Resorts (NASDAQ:WYNN), MGM Resorts (NYSE:MGM), and Melco Resorts (NASDAQ:MLCO) are all up over 19% so far this year, and the market seems to be getting more optimistic.

A lot of those gains were made (or regained) within the past month as Macao's May and June gambling figures were released. Rather than a decline in gambling, which was feared as recently as April when gambling revenue fell 8.3% year over year, the market has grown two months in a row. But if we take a step further back, there may not be as much reason for optimism for the Macao's gambling market as you would think. 

Macau's skyline from the water at night.

Image source: Getty Images.

The real story in Macao

Some of the market's reaction came after Macao reported a 5.9% increase in gambling revenue in June 2019. But one month rarely tells the real story in Macao, and volatility month-to-month makes growth numbers almost meaningless. You can see below that Macao gambling revenue over time has been steady, and maybe even falling slightly over the past year. This is hardly a growth market for investors.

Graph of Macao monthly revenue from gambling activities.

Image source: Macao's Gaming Inspection and Coordination Bureau. Chart by the author.

Macao is a volatile market, so ups and downs are normal, but the market's bullishness doesn't seem to match up with what we're seeing on the ground. And when you account for increased supply hitting the market, there's even less reason to be bullish. 

Supply will dilute casino profits

The problem with stagnant demand in Macao is that supply is increasing. MGM Resorts recently opened MGM Cotai, Melco Resorts is opening a new tower on Cotai, SJM will open a new property within the next year, and Galaxy will open phase 3 of its massive property to the public in 2020. And these are just the biggest developments in gambling, and don't cover smaller additions to hotel or casino supply. 

Add it all up and Macao needs to grow casino gambling revenue in order for these operators to maintain profits. But that's not what's happening in Macao. 

The value trap

Flat revenue wouldn't be a problem if casino companies were trading for a good value, but each of these stocks trades at a historical premium. Below, you can see that enterprise value to EBITDA ratios range from 12.0 to 13.1, which is above the market's historical EV/EBITDA multiple average of 10.6 (1992 to 2017) and over the 10.0 multiple threshold that I think indicates a good value in the gambling industry.

LVS EV to EBITDA (TTM) Chart

LVS EV to EBITDA (TTM) data by YCharts

If the increasing supply of properties in Macao does eat away at profits, it means these stocks should actually trade at a discount. But that clearly isn't the case today. 

Why Macao matters so much

The harsh reality is that Macao drives everything in the casino industry. It's where a majority of cash flow comes from, and it's where the market looks for growth. So far this year the market is seeing better growth than expected, but if you take a step back it may actually be time to be skeptical of the industry's growth prospects.