Crown Resorts (CWN) – a buy with a $21.30 target

Chief Investment Officer and founder of Aitken Investment Management
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Today I wanted to reiterate our investment thesis on Crown Resorts (CWN). I think it’s important not to get distracted by personal sideshows involving the executive chairman. That statement doesn’t mean I condone the sort of behaviour witnessed in Bondi on Sunday afternoon, but my job in writing investment strategy is to focus on the business fundamentals and investment case.

Crown Resorts has been on our high conviction buy list for many years (See our November note here). Backing James Packer’s vision of building a regional destination entertainment business to cater to the rise of the Chinese middle class has been very rewarding. While both CWN and Melco (MPEL) shares, (down 9% and 21% respectively), have seen some profit taking in the shorter-term from record highs, I see that as just another buying opportunity, with both stocks offering genuine growth at a reasonable price (GARP) characteristics to a truly structural growth theme: the rise of the Chinese international tourist. The combination I call “structural GARP”.

The China factor

While many commentators, including myself, worry about many things that China is facing, the one sector I do not question is the structural growth in Chinese international tourism. Quite simply, if you build it they will come. And they are coming, even to Australia as the Wall St Journal reported last week in the graph below.

But to capture the Chinese outbound market, we have to firstly get them here and, secondly, offer a product they want. The fall in the Australian dollar is helping Australia’s relative value proposition, and should continue to. Airline capacity from mainland China to Australian capital cities is now at an all-time record, and continues to rise, as advances in commercial jet range/fuel efficiency and passenger capacity encourage more Asian carriers to fly to Australia.

In terms of product, it has to be luxury entertainment plus gaming, which Crown has built in Melbourne and Perth. The Sydney property will take that offering to a whole new level and my personal view is, as a person who has lived in Sydney his whole life, that Crown Sydney will be a monumental international and domestic visitor success. Exactly like Marina Bay Sands in Singapore has been. In the graph below, it’s worth noting overall Chinese tourist numbers to Singapore lifted 68% after the opening of Marina Bay Sands (2009). This will come to Sydney in 2019.

No doubt the existing domestic casinos have been a fraction disappointing in the last 12 months in terms of revenue growth/operating profit, but if you back the Melco Crown Entertainment (NASDAQ:MPEL) shareholding value/ earnings/dividend contribution out of the Crown valuation, you are effectively buying Crown’s domestic casinos at a discount to Echo Group’s (EGP) casinos, which appears the wrong way around to me. Crown management is working hard to return the domestic businesses to positive JAWS (revenue growth outpacing cost growth) and I think the worst of performance is behind the Crown domestic businesses. Hopefully, we will see confirmation of that at the full year results in August.

The jewel

But to me, that isn’t the key to Crown: the KEY is GROWTH of new properties that are specifically China outbound tourist facing. To remind you of the development pipeline:

2014 = City of Dreams Manila
2015 = Studio City
2016 = Perth Crown Towers
2017 = City of Dreams (fifth tower)
2018 = non-gaming Sydney
2019 = Crown Sydney

That is a substantial development growth pipeline that sees new top line revenue growth added to the group each year until 2019. The good news for shareholders is that the development will be internally funded by either Melco Crown or Crown, from Melco Crown dividends.

In our Crown forecasts, we hold annual dividends flat for the next few years, feeling the decision to internally fund development rather than lift short-term dividend payouts is the right decision for long-term Crown shareholders. Crown shareholders can look forward to a substantial dividend lift in five years time, when the growth investment capex ends and the profitability base is significantly higher.

The -21% pullback in Melco (MPEL.NAS) shares is not fundamentally driven by any change to the earnings outlook. With the benefit of hindsight, it’s clear Melco had some momentum investors on the register and they appear to have been flushed out. The chart below tracks 2014 consensus EPS forecasts of Melco and the Melco share price. I’d be buying this gap with Melco now trading back on 20x forward earnings and offering 68% EPS growth. On PEG multiples, Melco is cheap again.

MPEL 2014 EPS vs MPEL share price

The Melco share price bottoming out and recovering is clearly an important call to Crown sentiment. With Melco contributing 50% of Crown NPAT in FY15 (est), there should be no doubt that the increasing correlation between the two stocks, albeit Melco is the higher beta one, is fundamentally justified. The chart below shows that Melco overshoots and undershoots Crown but also that Melco has bottomed on this pullback.

Interestingly, in the associated pullback in Crown shares, there has been no change to FY15 consensus EPS estimates, which simply means the stock is better value than it was. Consensus sees $1.01 EPS from Crown, we are at $1.05, comfortably ahead of the current consensus forecasts.

CWN vs FY15 consensus EPS forecasts

Crown Resorts has pulled back to the best risk adjusted GARP proposition I can remember in years of supporting the stock. On our FY15 estimates, you can buy another year of 20% EPS growth for just 15.8x earnings. FY15 EPS will be more than 2.38x the EPS delivered in FY11, while consensus sees further double digit EPS growth in the forecasting future.

Don’t pull your punches

With Consolidated Press Holdings controlling 50.1% of the register, you get only a few chances to add to Crown at what are value multiples. History suggests you have to be nimble in Crown pullbacks and that is why I am reiterating our top down and bottom up buy recommendation on Crown today.

Crown is a structural growth stock for the Asian century and one of very few Australian stocks NOT dependent on ultra-low cash rates, commodity prices or high dividend payout ratio for share price rating.

As we enter the tougher part of the equity market moneymaking cycle, I want to back the right people running the right assets at the right price. I also want the best bottom up leverage I can get to a structural top down growth theme, at the right price.

Crown remains a high conviction buy with a $21.30 price target (20x FY15).

Go Australia, Charlie

100% of Charlie Aitken’s fees for writing for the Switzer Super Report are donated to The Sydney Children’s Hospital Foundation

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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