Melco Resorts & Entertainment Limited (NASDAQ:MLCO) continues to post impressive revenue growth and its prospects have never been brighter. However, my main concerns are around how the company is managing its balance sheet, and whether their current financial status is sustainable. I will conduct a high level fundamental analysis on the company by looking at its past financials and growth prospects moving forward.
Firstly, a quick intro on the company – Melco Resorts & Entertainment Limited, through its subsidiaries, develops, owns, and operates casino gaming and entertainment casino resort facilities in Asia. Since starting in 2004 in Hong Kong, the company has now grown to a market cap of US$15.53B.
The company is growing incredibly fast, with a year-on-year revenue growth of 16.94% over the past financial year , and a bottom line growth of 97.27%. Over the past five years, revenue has grown 3.30%, boosted by prior years of higher capital expenditure, which most recently reached US$514.99M. With continual reinvestment into business operations, a return on investment of 24.36% is forecasted for the upcoming three years, according to the consensus of broker analysts covering the stock. Net income is expected to increase to US$576.06M in the upcoming year, and over the next five years, earnings are expected to grow at an annual rate of 22.27% on average, compared to the industry average growth of 12.22%. These numbers tell me that MLCO has a robust history of delivering profit to shareholders, with a disciplined approach to reinvesting into the company, and a bright future relative to its competitors in the industry.
MLCO’s financial status is a key element to determine whether or not it is a risky investment – a key aspect most investors overlook when they focus too much on growth. A major red flag for MLCO is its high level of debt, which has been increasing over the past five years, exceeding its total level of equity. Furthermore, its interest payments as a result of this high level of debt, is not adequately covered by EBIT, at 2.5x. However, its cash generated from its core activities makes up a reasonable portion of debt (0.3x). There’s room for improvement on the debt level front, which could be lowered to a more prudent amount. The current state of MLCO’s financial health lowers my conviction around the sustainability of the business going forward. MLCO has high near term liquidity, with short term assets (cash and other liquid assets) amply covering upcoming one-year liabilities. MLCO has managed its cash well at a current level of US$1.51B. However, more than a fifth of its total assets are physical assets and inventory, which means that in the worst case scenario, such as a downturn or bankruptcy, a significant portion of assets will be hard to liquidate and redistribute back to investors.
MLCO currently trades at US$31.37 per share. At 489.8 million shares, that’s a US$15.53B market cap – which is about right for a company that has an upcoming 2018 free cash flow figure of US$1.12B. Even with an expected negative FCF growth rate of -0.022% (source: analyst consensus), the target price for MLCO is US$32.90, approximately around the recent share price. Therefore the stock is priced around its fair valuation. Although, comparing MLCO’s current share price to its peers based on its industry and earnings level, it’s overvalued by 99.81%, with a PE ratio of 44.23x vs. the industry average of 22.13x.
If you’re thinking about buying MLCO, you have to believe in its growth story, which is a strong one. However, my main reservation with the company is its financial health, as well as the possibility that it is currently overvalued. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.