Is It Time to Reconsider Las Vegas Sands?

When you live in Las Vegas, you can't go too far without bumping into folks who are very interested in what's going on at the major casino companies. As it happened, at a party the other night, I ended up chatting with an investor very intrigued by the recent drop in Las Vegas Sands (NYSE: LVS) thanks in large part to the he-said-he-said drama going on there.

Back in January, I wrote that I'm a fan of the company, but didn't like the price tag on the stock. Even after a big jump yesterday, it's still down 16% from the early January highs, so is it a good time to buy? Let's take a closer look.

Earnings expectations
As I outlined in a previous article, a good way to get a baseline for growth expectations is to check on what Wall Street analysts expect and how fast the company has actually grown in the past.

Source: Capital IQ, a Standard & Poor's company. Historical growth based on per-share operating income.

Now comes the tough part: How fast do we actually believe Las Vegas Sands can grow? This is a very tough question and one that isn't informed very well by historical numbers. There are growth drivers aplenty for Sands. First and foremost there's Marina Bay Sands in Singapore. The property is an absolute monster and it hasn't yet contributed a full year of operations to Sands' results. In the fourth quarter, Sands' total adjusted property EBITDA grew 141% year-over-year and that was largely thanks to the addition of Marina Bay.

In addition, there's the ongoing construction on parcels 5 and 6 on the Cotai Strip in Macau. There's been some holdup on the construction front for those properties, but, when completed, they will significantly expand Sands' Macau footprint. There's a bit of a question mark about what will happen with parcels 7 and 8, but those could factor into growth as well. And of course we can't totally count out the potential for further recovery in Las Vegas operations.

Earnings per share were $0.51 for 2010, but analysts are looking for $1.78 this year. That latter number is believable largely thanks to Marina Bay -- the annual EPS run-rate as of the fourth quarter was $1.36. A further jump to $2.23 is expected for 2012.

Starting with $1.36, rather than $0.51, as my base-year EPS, I set my midcase scenario to 20% annual growth. This is likely even more bullish than it sounds because growth in total profits may be offset a bit by increases in share count. Between 2007 and 2010 the company boosted diluted share count by 122%. For my upside case I used 30% growth, while my downside case is still a none-too-shabby 15% per year.

Pinning down valuation
Valuations are a moving target that can be tough to predict, but, as with growth above, using a range of values can give us a view of our potential returns without requiring a Miss Cleo-type prescience.

In creating that range, often a good place to start is where the stock is trading right now and what its historical trading range has been. Unfortunately, unless we're wild-eyed optimists, neither the current price-to-earnings ratio of 84 nor the historical range -- which peaked at 219 in 2008 -- is particularly useful. The stock's forward P/E of 21.7 may be a better starting point.

For broader context we can also look at how similar companies trade.

Source: Capital IQ, a Standard & Poor's company. NM = not meaningful.

Obviously these businesses aren't all exactly the same as Sands. Wynn may be the most comparable, but even it lacks Sands' geographical diversity. MGM is largely weighed down by Vegas-based properties and the CityCenter debacle, while Ameristar focuses on properties outside of the big gaming destinations. And of course the others on the list are cashing in from rooms rather than slot hold (or rolling-chip winnings, as the case may be). However, the group can still help us build a valuation range.

Considering Sands' expected growth, its forward P/E seems pretty reasonable compared to the rest of the group. Of course, it's notable that the hotels are still in recovery mode from recession-induced profit drops, and P/Es will likely decline as profits recover. Additionally, depreciation -- which folks in the casino and hotel industry often like to ignore -- tends to be much more of a real cost for gaming companies than hotels, so there may be less of an argument for accepting an inflated P/E since so much reinvestment has to flow back into the business.

For my midcase, I've set Sands' P/E at 20. That's a drop from where it is currently, but still generous enough that it makes the conservative investor in me uneasy. On the upside, I could see investors paying 25 times earnings five years from now, while I've set the lower end at 15.

Dividends
Our final stop is to consider how much we'll get paid through dividends. This is an easy one: Sands doesn't pay a dividend, and I don't expect that it will introduce one in the next five years, so we can simply zero this out.

The verdict please!
The end result of all of this is the returns we can expect under the various scenarios. Here's what my three scenarios would look like.

Source: author's calculations.

The upside case on Sands is very tantalizing. With that kind of an annual return, the stock would triple over the next five years. The more reasonable middle case is much less impressive. While 10% annual returns isn't terrible, I believe investors can get better returns right now from more conservative, less indebted large-cap stocks. And even without painting a particularly bleak downside case, the returns on that scenario would be very disappointing.

Overall, I think Sands could be a good investment right now for investors who want to chase the upside case -- or something close to it -- and are willing to accept potentially disappointing returns if the company falls short of the high-growth bar. For investors looking for a core portfolio holding, I think there are better choices right now.

Of course, the future is an ever-changing picture, so you need to keep on top of what's going on at Sands to see whether it's living up to the market's high expectations. You can do just that by adding Las Vegas Sands to your Foolish watchlist.