Weak Yuan Manageable for Wynn

The devaluation of the yuan against the U.S. dollar last week pressured the shares of

The Macau operators do not have translational risk from yuan depreciation. Sales and expenses derived in Macau are denominated in the pataca, the region's legal currency. The pataca is pegged to the Hong Kong dollar, which is in turn pegged to the U.S. dollar. If the yuan continues depreciating, it will face decreased purchasing power relative to the Hong Kong dollar; this could have a negative transactional impact on those operating in Macau. But further yuan depreciation could result in Hong Kong devaluing its dollar to stay competitive with other countries. This would neutralize the purchasing power headwind and create a manageable translation headwind. For instance, a 1% change in the U.S. dollar/pataca exchange rate equals a gain or loss of $13.7 million for Las Vegas Sands, which is manageable based on our 2016 net income estimate of $2.3 billion for the firm.

Over the past one- and three-year periods, the yuan has seen midteens and high 30s appreciation, respectively, versus the Japanese yen. This could be why China has now decided to devalue. Regardless of the reason, we maintain our narrow moat ratings on Wynn and Sands and our no moat rating on MGM. We also maintain our fair value estimates. We believe Wynn's current share price assumes flat Macau sales and margins over the medium and long term, which we view as unlikely, given the long-term Macau growth we see.

Macau's Long-Term Growth Holds Opportunity We view Wynn Resorts as a well-established, high-end, iconic brand that is positioned to participate in the attractive long-term growth opportunity of Macau as it expands its room share to 9% from 6% through the Cotai Palace opening in 2016. The offset to this expanded room presence is the continued shift away from VIP and gaming revenue (where Wynn has outsize exposure) toward nongaming and mass play, as well as its existing Macau property being located on the peninsula, where traffic has lagged Cotai.

It is not unreasonable to expect Macau visitation and revenue to reaccelerate to above a mid-single-digit pace in a few years, as new casinos open in 2015-17 (increasing Macau room supply toward 43,000 from 28,000 currently), infrastructure is built out in 2017 and beyond (easing overcrowding and accessibility issues), and nearby Hengqin Island is developed over the next decade (3 times the development area of Macau). This increased supply should easily be matched with demand, as the population within a few hours of Macau is 7 times that of Las Vegas, yet the numbers of Macau rooms and visitors were only one-fifth and three-fourths those of Las Vegas in 2014. Holding one of only six gaming licenses, Wynn stands to benefit from this growth. That said, the Macau market is highly regulated, and as a result the pace and timing of growth is at the discretion of the government.

In Las Vegas, Wynn's casino properties generate industry-leading EBITDA (around 30% higher than the next-largest property, Bellagio). Las Vegas doesn't offer the long-term growth potential or regulatory barriers of Macau, so we do not believe the region contributes to Wynn's moat. But there have been very minimal industry supply additions this decade, and that is is expected to continue over the next few years, supporting solid industry Strip occupancy (93% in 2014).

Wynn Brand and Macau Assets Provide Moat We think Wynn Resorts has a narrow moat, driven by both its established brand and gaming concession intangible assets in Macau. Wynn is synonymous with high quality, and it holds more Forbes 5-star awards than any other independent hotel company in the world. Its past success with Bellagio and Mirage in Las Vegas aided the company in winning a gaming license in Macau, where government regulation creates meaningful barriers of entry for new competition. Further, this continued success in Macau helped the company win the only gaming concession awarded in the Boston market, where the company plans to open a resort in 2017-18. This continued execution of building and operating some of the best integrated resorts in the world positions Wynn Resorts to win concessions in any future gaming markets (Japan, South Korea).

In Macau, there are only six gaming licenses, which are not up for renewal until 2020-22. We believe these concessions are likely to be renewed or extended for the current operators, as they have invested meaningful investment capital and helped positively develop the Macau economy. Given the limited land available to develop and the government's seeming preference to control growth of the region, we also think it is likely that there will not be any meaningful new gaming concessions or table allocations presented at the time of renewal. As a result, we see a continued controlled limited supply of competition for the Macau market over the next decade supporting our narrow moat rating.

Wynn Resorts has a fair presence in the supply-controlled Macau market, as its 14% EBITDA share amongst the six gaming concession operators in Macau is roughly in line with its fair share. This 14% EBITDA share is well above its current 6% room share, as the Wynn Macau is among the top EBITDA generating properties in all of Macau. The Wynn Macau is located on the Macau peninsula and not on the Cotai Strip, where the mix of traffic has migrated. That said, Wynn hopes to open its Cotai Palace property sometime in 2016, which will increase its room share to 9% from 6% among the six concessionaires once the upcoming industry supply increase is complete in 2017. Wynn's Macau room count then may increase by another 1,500 by 2018-19 with the second phase of the Cotai Palace, which would bring total room count to 4,200.

We see the Las Vegas region as not having a moat due to lower regulatory barriers, which increases competition, leading to lower returns on invested capital. Although the region does not contribute toward Wynn's competitive advantages, it is encouraging that current supply and demand is better now than a few years ago. After 79% and 24% room supply growth in Las Vegas during the 1990s and the first decade of this millennium, respectively, room supply has increased just 1% through 2014, and the outlook is for no meaningful supply additions on the Strip during the next few years, which should help sustain Las Vegas Strip industry occupancy at healthy 2014 levels of 93%. Additionally, the large number of resorts and composition of Las Vegas (70% nongaming and 30% gaming) helps support relative healthy and consistent visitation (repeat visits with plenty to do and see), which cannot be replicated by the U.S. regional market. That said, we believe regional casinos will continue to place competitive pressure on Las Vegas' gaming business, resulting in low ROICs.

Wynn's consolidated ROIC and operating margin expansion offer quantitative support of our narrow moat rating. We believe ROICs will decline to still healthy midteen levels in 2015 and 2016 as capital expenditures are elevated in those years in front of the Wynn Palace (Macau Cotai) and Everett (Boston) projects. From there we forecast ROIC to increase to 27.4% in 2019, which is comfortably ahead of the firm's 8.0% cost of capital. Additionally, operating margins are modeled to reach 24.7% in 2024 from 23.3% in 2014.

Government control prevents us from considering a wide economic moat. While unlikely, the Macau/Chinese government could award additional gaming licenses that would increase market competition. In an extremely unlikely scenario, the government could exercise its right to seize and take control of all operations on the island, which would meaningfully affect the economic profit outlook of Wynn Resorts.

Economy Is Biggest Risk The principal risk to prospective shareholders is a slowdown or downturn in Macau (either macroeconomic or through government regulation) and the onset of a recession in the United States. In 2014, Wynn derived 56% of its total revenue from the Macau VIP player, a market segment that is sensitive to economic conditions, credit market conditions, interest rates, housing and stock market conditions, and the potential for a reverse wealth effect in the region. VIP rolling chip volume in Macau decreased in the double digits in the first half of 2009 amid the credit crisis and a steep decline in the Chinese stock market and has showed renewed signs of weakness due to anticorruption activities in China over the past several months.

A long-term risk is the potential for increased competition from other new integrated resorts in other countries in Southeast Asia and any expansion in the number of gaming licenses in Macau.

The Las Vegas Strip is a destination market that is highly cyclical and dependent on business travel and personal travel expenditures. During the last recession in the U.S., gaming revenue on the Vegas Strip declined 19%.

Additional risks for the company include something happening to founder Steve Wynn or damage to the Wynn brand name. Kazuo Okada continues to appeal Wynn Resorts' forcible redemption of his shares in 2012 (which represented approximately 20% of shares outstanding), and there is some risk that the redemption will be reversed by a court ruling.

Finally, the central government controls the number of gaming tables, labor for development projects, visas for Chinese visits to Macau, and may implement a full smoking ban that will have an outsize impact on VIP (VIP rooms currently still allow smoking). We expect upcoming table and labor allocations to be disappointing, leading to low near-term revenue potential and delays in industry development. We also would not be surprised to see some further visa restrictions on Chinese citizens.