Las Vegas Sands (LVS): High-Yield Dividend Income or a Risky Gamble?

Many founder-led companies can make for solid long-term investments, specifically when it comes to dividend stocks.

 

That’s because the founder and CEO owns a large stake in the business and often has a natural incentive to pay a generous and growing dividend, an appealing proposition for income investors seeking to live off dividends.

 

However, that doesn’t necessarily mean that all such companies are worth owning. After all, the ability to pay a secure, growing dividend largely depends on the business model of each company.

 

Let’s take a closer look at Las Vegas Sands (LVS), which is run by its founder, Sheldon Adelson, who along with his wife Miriam own 20% of the company’s shares worth over $9 billion.

 

Given the high levels of insider ownership, let’s see if Las Vegas Sands’ high dividend could be worth a roll of the dice for our Conservative Retirees dividend portfolio.

 

Business Description

Founded in 1988 in Las Vegas, Nevada, Las Vegas Sands is the largest publicly traded casino operator in the world.

 

It owns 12 major hotel and gaming resorts, as well as convention centers in three countries on two continents.

• The Venetian Macao (China)
• Sands Cotai Central (China)
• Parisian Macao (China)
• 4 Seasons Macao (China)
• Cotai Strip (China)
• Plaza Casino (China)
• Sands Macao (China)
• Marina Bay Sands (Singapore)
• Venetian (Las Vegas)
• Palazzo (Las Vegas)
• Sands Expo and Convention Center (Las Vegas)
• Sands Casino Resort (Bethlehem, Pennsylvania)

As you can see, fully two thirds of Las Vegas Sands’ properties are located in Asia, with 58% being located in Macau.

 

Macau is the world’s largest gaming market ($30 billion in 2016 gaming revenue), and the only place where gambling is legal in China.

 

 

In fact, Macau is by far the company’s most important source of sales, earnings, and cash flow.

 

 

While the company has started to diversify its revenue base away from pure casino gaming, thanks to its world-class hotel, food, and retail facilities, Chinese gambling remains the overwhelming source of the company’s business, making up 59% of sales in 2016.

 

Business Segment	2016 Revenue	% Of Revenue
Gaming	$8.8 billion	71.9%
Hotel Rooms	$1.5 billion	12.5%
Food & Beverage	$774 million	6.3%
Malls	$591 million	4.8%
Retail & Convention	$533 million	4.4%
Total	$12.196 billion	100.0%

Source: Las Vegas Sands Earnings Release

 

Business Analysis

Gaming is a purely discretionary industry, which means that sales, earnings, and free cash flow can be highly volatile.

 

That’s especially true for Las Vegas Sands because it’s so heavily dependent on Macau, which saw gaming revenues collapse in 2015.

 

The collapse was due to a strong corruption crackdown that scared away big gamblers (many of whom were Communist Party Officials and/or wealthy Chinese who the government has accused of using Macau to hide wealth offshore) and plunged the local economy into a depression.

 

 

This had a noticeable impact on Las Vegas Sands’ margins and returns on shareholder capital, which can also fluctuate largely over time thanks to various needs for profit-sapping promotions ($786 million in 2016).

 

While the company’s profits have taken a hit in recent years, thanks to both highly disciplined management, as well as owning some of the highest quality properties in the world (almost all of its resorts are 4 and 5 stars), Las Vegas Sands still boasts far better than average profitability relative to its peers.

 

Company	Operating Margin	Net Margin	FCF Margin	Return On Assets	Return On Equity
Las Vegas Sands	21.9%	14.6%	22.8%	8.1%	25.7%
Industry Average	4.0%	1.8%	NA	0.8%	5.1%

Source: Morningstar

 

That’s thanks in large to management refusing to invest in new overseas growth properties (in China, Singapore, South Korea, and Japan) unless it thinks it can achieve a long-term return on invested capital of at least 20%.

 

In addition, Las Vegas Sands benefits from good exclusivity in some of its regions. For example, in Singapore it has one of only two gaming licenses issued by the government, which allows its Marina Bay Sands resort to generate 50% EBITDA margins.

 

Meanwhile, an increasing focus away from big VIP gamblers and instead on families and smaller gamblers has resulted in a turnaround in both visitors and gaming revenue from Macau over the past year.

 

 

Further good news for shareholders is likely to come from the long-term growth prospects of Macau, which is expected to see continued strong increases in visits from mainland China thanks to the fast growth rate in Chinese middle class spending.

 

 

That’s especially true given that in 2016 just 1.5% of the population of China visited Macau.

 

In contrast, last year 12.7% of Americans visited Las Vegas, indicating enormous growth potential for the company’s Macau properties should China’s populace prove as gambling-friendly as its U.S. counterpart.

 

Better yet, because of its dominant position in Macau’s four and five star resort market, Las Vegas Sands is arguably best situated to profit from future Chinese gaming growth.

 

 

In other words, Las Vegas Sands, due to its increasing focus on Asian gaming growth potential, appears to be one of the best stocks you can own to profit from the future of global gambling.

 

However, that doesn’t mean that it is necessarily a good dividend stock, especially not for investors who need consistent and dependable income.

 

Key Risks

While there’s plenty to like about Las Vegas Sands, investors need to realize this company faces several major risks.

 

First, remember that, as with the gaming industry in general, the fortunes of Las Vegas Sands rise and fall with the global economy. Any economic downturn can result in a sharp decrease in revenue, profits, and free cash flow.

 

This is especially true in China, where not only has the economy been slowing lately, but also regulatory threats are a constant concern.

 

For example, while Macau gaming has had a nice recovery in 2016, in recent months it appears that this trend may have run out of steam.

 

 

Worse yet? Beijing recently clamped down yet again, cutting in half the amount of cash that one is allowed to withdraw from an ATM per transaction.

 

In addition, China recently started requiring all foreigners to get fingerprinted when entering the country. This was a result of concerns that wealthy gamblers were using Macau (which has its own currency called the Pataca) to launder money and spirit it out of the country.

 

As China’s economy slows and its currency depreciates, the government has had to resort to tapping into its massive foreign currency reserves to prop up its currency (the Renminbi) in the face of a large amount of capital flight out of the country.

 

Las Vegas Sands, as well as all casino operators on Macao, including rivals Wynn Resorts (WYNN) and MGM Resorts International (MGM), face the grim prospects of government regulators continuing to clamp down, potentially stifling Macau’s growth potential over time.

 

There is also the risk of a major economic downturn in China, which has largely funded its amazing 30 years of nearly double-digit economic growth through one of the largest debt binges in human history.

 

 

That’s because China’s reaction to the 2008-2009 global financial crisis was to stimulate the economy by ordering its state-owned banks to make incredible amounts of low-cost loans to its state-owned enterprises.

 

However, this has created a major problem, one that Li Yang, senior researcher with the leading government think-tank the China Academy of Social Sciences, says could be a “fatal issue.”

 

While no one knows what will happen next, a recession in China would likely send gambling revenues in Macau plunging, and with it, Las Vegas Sands’ sales, earnings, dividend, and stock price.

 

Then there’s the currency risk the company faces from its high concentration in China, which causes challenges when the U.S. dollar strengthens (Las Vegas Sands converts its Macau earnings to U.S. dollars).

 

There is also the threat of rival resorts gaining market share, especially among the VIP high rollers that still make up the majority of Macau’s gaming revenue.

In fact, this is already starting to happen, with Las Vegas Sands’ last quarter showing declining VIP revenue (causing an overall sales decline) from its Macau properties despite Macau reporting a 25% increase in VIP gaming revenue.

 

However, my biggest concern that could really hurt Las Vegas Sands’ long-term earnings power is the potential for China’s government to allow more competition in Macau.

 

The Wall Street Journal published an excellent article summarizing this major risk. Macau is the only place in China where casino gambling is allowed, and the region was opened up to foreign operators such as Las Vegas Sands in 2002.

 

China’s government issued six licenses to operate casinos, and Las Vegas Sands holds one of them. Most of these licenses are up for renewal over the next five years, beginning in 2020 with SJM and MGM China.

 

The government can extend these licenses for at most five years before having to hold a public tender for them. However, The Wall Street Journal notes that there is a lot of pressure for China to “redraw the industry map” and allow for more local Chinese companies to get in on the action.

 

After all, the Macau government doubled the number of licenses from three to six back in 2005 without a formal bidding process. The potential for new competitors, higher taxes, and reduced concessions over the next five years could structurally reduce the 20%+ operating margins Las Vegas Sands enjoys today.

 

Finally, we can’t forget that the cost of building mega-resorts is horrendously expensive. For example, the Marina Bay Sands resort in Singapore cost $5.6 billion to construct.

 

Not just does this mean that Las Vegas Sands has to borrow heavily to fund its growth, but in addition 30% of its funding is derived from selling new shares.

 

Not only will rising U.S. interest rates mean higher capital costs in the future, but the company is highly dependent on the fickle and volatile stock market for its ability to raise growth capital.

 

Should the market face a major downturn in the coming years, Las Vegas Sands could find itself in a liquidity trap.

 

That’s where the share price might not be high enough to make a multibillion dollar resort profitable, which could force it to divert free cash flow away from its $2.9 billion dividend in order to complete a new property.

 

In other words, because of the inherently cyclical nature of its business model and the large number of uncontrollable factors impact the business, Las Vegas Sands doesn’t have the cash flow stability to offer a safe dividend for long-term investors.

 

Las Vegas Sands’ Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Las Vegas Sands has a Dividend Safety Score of 34. This means that despite its impressive dividend growth to date, investors need to be prepared for the possibility of a dividend cut over the course of a full economic cycle.

 

Las Vegas Sands’ dividend appears riskier than most even despite CEO Sheldon Adelson’s dedication to the company’s generous dividend.

 

In fact, during the last quarterly conference call he told analysts that “recurring dividends are the cornerstone of our return of capital policy and we remain committed to increasing those recurring dividends in the future as our cash flows grow.”

 

Of course, due to both the cyclical nature of the casino industry’s free cash flows, created by massive fluctuations in capex spending (to construct new resorts), even such reassurances don’t necessarily provide safety from occasional and painful dividend cuts.

 

For example, in 2015 Wynn Resorts slashed its dividend 67% due to falling gaming business in Macau. And keep in mind that Wynn’s dependence on Chinese gaming is a lot less than Las Vegas Sands’.

 

Now things might be different if Las Vegas Sands had very low payout ratios, which could provide a safety buffer in bad times.

 

However, as you can see below, the company has been paying out more in dividends than either its earnings or free cash flow (FCF) for the past two years.

 

 

Now in fairness to management, that was due to large amounts of spending to finish its newest Macau resorts.

 

With most of that construction done, the company’s free cash flow is set to increase substantially in the coming years, even if sales and earnings remain flat.

 

In fact, by 2019, the company’s lack of new growth spending will mean FCF of around $3.5 billion from today’s revenue levels.

 

That would create a FCF payout ratio of 83%. While that would be technically sustainable, it doesn’t leave much safety margin for any future downturns, much less any future growth spending on new Asian resorts.

 

 

 

Of course, we can’t forget that payout ratios aren’t the only important measure of dividend safety. We must also consider the strength of Las Vegas Sands’ balance sheet, which has nearly $10 billion of outstanding debt.

 

 

Fortunately, 83% of that debt is coming due in 2020 or later. While that is good news for dividend security in the short-term, it also means that the company is likely to face much steeper refinancing costs as interest rates rise in the coming years.

 

 

It’s important to remember that the casino industry is very capital intensive, so even Las Vegas Sands’ high debt load needs to be put in context.

 

As you can see, compared to its peers, the company’s balance sheet is actually quite strong, with much lower leverage ratios.

 

However, because of the cyclical nature of its sales and FCF, even Las Vegas Sands, which has one of the best balance sheets in the industry, is just one credit downgrade from junk bond status.

 

Company	Debt / EBITDA	Debt / Capital	Current Ratio	S&P Credit Rating
Las Vegas Sands	2.64	55%	1.10	BBB-
Industry Average	9.21	79%	1.11	NA

Sources: Morningstar, Fast Graphs, Simply Safe Dividends

 

Simply put, there is no room for error when it comes to financing its future growth properties. In a rising interest rate environment, and with $8 billion in debt coming due after 2020 (when the Federal Reserve projects interest rates will have risen another 2.25%), the company could be increasingly challenged to affordably refinance its debt with junk bonds.

 

While the dividend is likely safe right now, it will remain precariously perched on the edge of sustainability due to the unpredictable nature of the casino industry.

 

Las Vegas Sands Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Las Vegas Sands has a Dividend Growth Score of 66, which seems very good. Of course that’s mostly due to the company’s short but impressive payout growth record.

 

The company’s dividend has nearly tripled since 2012, growing at a 27.2% annual rate over the last three years.

 

 

Going forward, however, dividend investors shouldn’t expect anywhere close to that kind of payout growth.

 

After all, even if Las Vegas Sands increases its FCF in the coming years to $4 billion (from $2.65 billion last year), on the back of much lower construction spending and rising Macau gaming profits, that would still result in a very high FCF payout ratio above 70%.

 

Investors should hope that Las Vegas Sands chooses to grow the payout at just 3% to 4%, which would help the company’s payout ratios decline to more sustainable levels over time.

 

It looks like management is going down that path, announcing just a 1% increase to the company’s dividend earlier this year.

 

If management chooses to be more generous with dividend increases, say proportional to earnings growth, then the dividend will become highly variable and rise and fall with the company’s unpredictable short-term results.

 

Valuation

Las Vegas Sands’ stock trades at a trailing P/E multiple of 27.0, which is a premium compared to its industry peers but is about in line with the company’s historical multiple.

 

However, what is most important for dividend investors is dividend yield. In fact, this is what attracts most dividend investors to the stock, since the current yield is trading at such a significantly higher level than both its historic norm and most other global casino stocks.

 

Company	P/E	Historical P/E	Dividend Yield	Historical Yield
Las Vegas Sands	27.0	27.4	5.2%	2.9%
Industry Median	22.0	NA	2.3%	NA

Source: GuruFocus

 

While it may appear that Las Vegas Sands is attractively priced, especially from a yield perspective, keep two important facts in mind.

 

First, the company’s dividend record is very new, with the first dividend paid out in 2012. That means we have yet to see how the stock’s payout will fair in a global economic recession.

 

Second, because of the newness of the dividend record, the low historical median yield is largely a result of the much lower payout back in 2013 and 2014, when the average FCF payout ratio was a much safer 55%.

 

Given the current payout ratio in excess of 100%, which signals a potentially unsafe dividend, you need to keep in mind that the stock’s mouthwatering dividend could very well prove to be too good to be true.

 

In other words, Las Vegas Sands may not be compensating investors for the risk to its future income generating abilities.

 

That’s especially true given that Las Vegas Sands has a beta of 1.85, indicating that the stock’s price has been much more volatile than the S&P 500.

 

In fact, Las Vegas Sands is one of the most volatile stocks in the market, declining 98% from its October 2007 highs to its March 2009 lows.

 

This shows just how potentially gut-wrenching the share price can be, making Las Vegas Sands unsuitable for conservative income investors.

 

Closing Thoughts on Las Vegas Sands

When it comes to casino stocks, Las Vegas Sands is arguably the best in its class, with a relatively strong balance sheet, exceptional management, leading market share, and reasonable long-term growth prospects.

 

However, the cyclical nature of the industry, as well as regulatory uncertainty in China and the massive costs of new resorts, mean that the dividend is likely to be highly variable over time.

 

Most investors searching for stable and dependable yield are better served avoiding Las Vegas Sands or any other casino stock. Instead, review some of the best high dividend stocks here.