MGM Resorts trades at $37.93 per share and has stayed right on track with the overall market, gaining 7.8% over the last six months. At the same time, the S&P 500 has returned 8.1%.
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Why Do We Think MGM Resorts Will Underperform?
We're sitting this one out for now. Here are three reasons we avoid MGM and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term performance is an indicator of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Over the last five years, MGM Resorts grew its sales at a 13.7% annual rate. Although this growth is acceptable on an absolute basis, it fell short of our standards for the consumer discretionary sector, which enjoys a number of secular tailwinds.
2. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, MGM Resorts’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
MGM Resorts’s $31.45 billion of debt exceeds the $1.96 billion of cash on its balance sheet. Furthermore, its 12× net-debt-to-EBITDA ratio (based on its EBITDA of $2.38 billion over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. MGM Resorts could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope MGM Resorts can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We cheer for all companies serving everyday consumers, but in the case of MGM Resorts, we’ll be cheering from the sidelines. That said, the stock currently trades at 16.2× forward P/E (or $37.93 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are superior stocks to buy right now. Let us point you toward the most dominant software business in the world.
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