The Stock

The Trade: Melco Crown Entertainment (NSDQ: MPEL)–Buy < 12.75.

Why Now: The company should continue to post robust earnings growth, fueled by limits on the number of gaming tables in Macau and rising household incomes in China.

The Story

Although late October brought the first light snow of the year, Elliott and Yiannis’ spirits are high after uncorking a much-needed bottle of Bordeaux to celebrate the end of another work week. Roger Conrad, co-editor of Big Yield Hunting and the recently launched Australian Edge, walks in on cue as the cork is removed from the bottle.

Roger: Hey, guys. What are you pouring tonight? I’ve been scouring quarterly results all week for Canadian Edge and Utility Forecaster. I need something good to get me through the backlog of earnings and conference call transcripts.

Elliott: Sorry to disappoint, but this is a work-related meeting.

Roger: I’ve wandered into yet another issue of Cocktail Stocks?

Yiannis: That’s right, man. We’re going to put you to work.  

Roger accepts a glass of wine from Elliott.

Roger: In that case, I’ll also need some food.

Elliott: You’re in luck, man. We’ve got a boudin-noir [a dark-hued blood sausage] cream soup with red peppers and pineapples. I think you guys will enjoy it.

Yiannis spoons some of the soup into his mouth and exclaims excitedly in Greek.

Elliott: Everything all right?

Yiannis: The soup is incredible. Is this your handiwork?

Elliott: Had to prepare for the cold weather.

Roger: You sure I didn’t just walk into the recipe planning session for the December issue of Better Homes and Gardens?

Elliott: On that note, let’s talk shop. Yiannis, what’s your outlook for the stock market?

Yiannis: Global markets appear oversold, but macro-level uncertainties continue to rule the tape.

Elliott: Thank you, Europe. If the EU would take decisive action to stabilize the situation in Greece and the other Club Med countries…

Roger: Ok, this is definitely an issue of Cocktail Stocks.

Yiannis wanders away from the group and pours the remaining wine into his glass.

Elliott: Ah, Greek austerity.

Yiannis: Easy there. I’m not happy about the Continental situation, either. There’s no denying that the risk of a systemic credit crisis emanating from Europe has increased.

Roger: True. But if you can pull your eyes away from that slow-motion train wreck, there’s a lot of positive news elsewhere in the world.

Elliott: The good news is getting lost in the shuffle. As much as I like to malign the EU–especially when Yiannis is around–policymakers ultimately should come up with a solution that at least stabilizes the situation in the near term. I still think that investors should take advantage of weakness in the stock market to build positions in high-quality names that offer exposure to long-term growth trends.   

Yiannis: Ah, long-term growth trends. China isn’t at risk of lapsing into recession.

Elliott: A British friend of mine was in China recently for business. But all he talked about was Macau when I asked him about the trip.

Yiannis: He was blown away?

Elliott: Yeah, he had a blast. He raved about the first-class casinos and accommodations.

Yiannis: I told you, man. Forget Las Vegas; Macau is the place to be. Macau casinos’ gross gaming revenue surged more than 40 percent from year-ago levels in October–a record high.

Roger: Wow. That’s just from gambling?

Yiannis: More than USD3 billion in one month.

Elliott: Impressive.

Yiannis: The casinos in Macau could easily rake in USD35 billion worth of revenue this year, if not more.

Roger: I guess the rich will be spending more money in Macau this year.

Elliott: Makes sense. After all, China’s real interest rate is negative.

Yiannis: I’m going to open another bottle of your wine.

Elliott: Go for it. You need to stick around to tell us more about Macau. My friend having a great time at the casinos there isn’t exactly an investment thesis.

Roger: Yiannis, didn’t you highlight a pure play on gaming in Macau a while back?  

Yiannis: Roger Conrad, income investor extraordinaire and faithful Global Investment Strategist reader.

Roger: What was that company’s name?

Elliott: Melco Crown Entertainment (NSDQ: MPEL), another fast-moving stock.

Roger: In both directions, according to this price graph.

Yiannis: That’s the deal with fast movers.

Elliott: I started to dig into this company because my friend stayed at one of their hotels.

Yiannis: Did he stay at Altira Macau or City of Dreams?

Elliott: Altira Macau. He said the hotel had one of the best Chinese restaurants in the world.

Yiannis: That would be Ying.

Elliott: That’s right. He said the food was out of this world.  

Roger: I can see I’ll need to rein this in before you guys start talking about food again–Yiannis has that gleam in his eye. Elliott, what did you find out about the company?

Elliott: Melco Crown Entertainment is one of six companies approved to operate casinos in Macau. A former Portuguese colony, Macau is a special administrative region of China that’s about 11.4 square miles in area and the only place in China where gaming is legal.

Yiannis: Macau’s unique status has enabled the casinos to post some eye-popping numbers. In 2010 the region generated USD23.5 billion in gaming revenue, compared to $5.7 billion in Las Vegas and $3.6 billion in Atlantic City, NJ. Macau–not Las Vegas–is the world’s largest gaming center. From 2005 to 2010, gambling revenue in Macau has grown at an average annual rate of 32.5 percent. Business in Las Vegas has remained relatively flat over the same period.

Elliott: I wouldn’t bet against Macau’s extraordinary growth. China’s rapidly expanding economy has led to rising household incomes and the emergence of a growing class of high-net worth individuals. As the only gambling outlet in China, Macau should be able to grow its gaming revenue at an average annualized rate of about 20 percent in coming years.

Demand should also receive a boost from a number of infrastructure projects that will make Macau, more accessible from the Mainland. This list includes a ferry terminal near City of Dreams, new high-speed rail links that will dramatically cut travel times from the Mainland, and a bridge that will connect Hong Kong and Macau.

Yiannis: Don’t forget the supply side. The Macau government limits both the number of casino licenses and the number of overall gaming tables.

Current rules restrict the number of gaming tables to 5,500 through the end of 2012. (The area’s casinos hold 5,237 gaming tables as of the most recent count.) In late September 2011, the government announced that the number of tables will be allowed to grow only 3 percent annually after 2013. These restrictions will be in place for at least 10 years, limiting the number of new resorts that open and ensuring that licensed casinos are packed with patrons.

Roger: That’s a compelling growth story. What makes Melco Crown Entertainment the best bet on Macau’s continued growth?

Elliott: Let me set the scene a bit more. Melco Crown Entertainment’s newest property, City of Dreams, features a 420,000 square foot casino that houses 400 gaming tables and 1,300 gaming machines. The complex includes the 800-room Grand Hyatt Macau hotel, as well as the Hard Rock Hotel Macau and Crown Towers, each of which has 300 rooms.

The development also boasts more than 20 restaurants and bars and 69 retail outlets, as well as a complement of swimming pools and fitness clubs. Melco Crown Entertainment plans to add a five-star hotel and more VIP rooms for high rollers.

Altira Macau has a 173,000 square foot casino and 228 gaming tables. The casino’s multiple floors include restricted VIP sections for wealthy gamblers. The 38-story hotel is widely regarded as one of in Macau’s finest, and the resort’s high-end restaurants also cater to guests with wealth and taste.

Yiannis: VIPs are particularly important to Melco Crown Entertainment’s business, accounting for about 75 percent of the company’s annual revenue and 50 percent of its annual profit.

Roger: Sounds like a good bet on big spenders. But if the company’s outlook is so rosy, why has the stock plummeted from about USD16 in August to about USD7 in October?

Elliott: Investors continue to fret that the Chinese economy is headed for a hard landing; a severe slowdown in economic growth would weigh on casino revenue.

Yiannis: As a dedicated reader of Global Investment Strategist, Roger should know my outlook for the Chinese economy.

Roger: Of course, man. You’re not worried about inflation in China.

Yiannis: That’s right. Although economic activity in China has slowed from early 2011, the quintessential emerging market’s gross domestic product should grow roughly 9 percent this year. Recent data points indicate that tightening fiscal and monetary policy has cooled the formerly white-hot economy to sustainable levels of growth. Inflation has also moderated, reflecting a decline in food and energy costs. This success may prompt Beijing to institute growth policies to alleviate fears of a recession.

Roger: You guys have built quite a case for investing in Melco Crown Entertainment. Are there any company-specific challenges worth mentioning?

Yiannis: Some critics worried about increased competition from the USD2 billion Galaxy casino and hotel, which features an artificial beach and wave pool. Run by Hong Kong-based billionaire Lui Che Woo, the casino is also situated on the Cotai Strip. But in the third quarter, Melco Crown Entertainment was the only casino operator in Macau that didn’t lose market share to Galaxy.

Elliott: Shares of Melco Crown Entertainment trade at less than 1.9 times sales, compared to 3.2 times sales for Wynn Resorts (NSDQ: WYNN) and 3.9 times sales for Las Vegas Sands Corp (NYSE: LVS). Both US-based firms have opened casinos in Macau. This wide valuation gap is unwarranted.

The stock has rallied from its October low and has significant technical support between $9.50 and $11. As concerns about China’s economy fade, the stock could easily retest its summer high a about $16–a rougjly 45 percent rally from current levels. Melco Crown Entertainment rates a buy under $12.75.

Commentary on Open Positions

August 2010: Vale (NYSE: VALE)–Buy < 30

Although commodities prices will moderate if the global economy slows, blue-chip miners are the place to be for a potential turnaround.

Spot prices of iron ore have tumbled recently because of weak demand in Europe. The big miners have redirected their shipments to China, a move that’s led to a bit of any oversupply in that market. Nevertheless, Vale’s long-term growth story remains intact.

September 2010: Teekay Tankers (NYSE: TNK)–Buy < 10

A 20 percent yield is Teekay Tankers’ only saving grace. We have been in this trade long enough that all the bad news has been priced into the stock, even lower day rates on the spot market in 2012.

November 2010: True Blue (NYSE: TBI)–Buy < 15

Our investment thesis for TBI remains intact. Part-time work will account for a greater proportion of the US labor market. This high-beta stock should spike once it becomes clear the US economy will avoid recession. The company’s business continues to strengthen, bolstered by the recent strength of Boeing (NYSE: BA), a major client.

February 2011: ProShares UltraShort 20+ Year Treasury (NYSE: TBT)–Buy < 30

Betting against US Treasury notes has been a losing proposition. This position could recover some lost ground when investors rotate funds from safe havens to equities. This exchange-traded fund is the definition of a fast mover.

May 2011: TAL International (NYSE: TAL)–Buy < 35

TAL International is the top company in the shipping industry, and its stock will rally if global trade doesn’t collapse. Demand has remained fairly resilient, though container prices have declined. We will continue to monitor the situation closely.

June 2011: iShares MSCI Italy Index (NYSE: EWI)–Buy < 15

This play on Europe’s turnaround is less risky than our Greece-related bet. The Greek experiment may force the EU to deal more decisively with Italy’s fiscal challenges.

July 2011: TransGlobe Energy Corp (NSDQ: TGA)–Buy < 12

This small-cap oil producer has pulled back amid concerns that an economic slowdown will weigh on energy demand and prices. This speculative stock will outperform in a bull market and underperform in a bear market.

July 2011: Market Vectors Gulf States Index (NYSE: MES)–Buy < 23.50

This exchange-traded fund has held its own we featured it in the July issue, especially given the performance in the global markets during the same time frame. We’re holding out for a powerful upsurge.

August 2011: National Bank of Greece (NYSE: NBG)–Buy < USD1.45

This stock is our most speculative play to date and is only appropriate for aggressive investors who can stomach a bet that’s based solely on a turnaround in Greece. A resolution to Greece’s sovereign-debt crisis is far from a foregone conclusion, and National Bank of Greece has a lot to lose.  

September 2011: China Cord Blood Corp (NYSE: CO)–Buy < 4

Don’t let near-term volatility shake you out of this stock; this bet will pay off over the long term.  

October 2011: Infosys (NSDQ: INFY)–Buy < 55

Shares of Infosys could rally even further if the stock market finishes the year on a high note. Investors should adhere to our buy target and only add to their positions if the stock dips below 55.