This Macau Pure Play Has Almost Tripled Already -- And Still Has At Least 100% Upside

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If you spend a lot of time researching investments, then you've probably heard of Macau, a former Portuguese colony consisting of two islands in the South China Sea and a small peninsula on the south coast of China. As you may know, Macau has gained a reputation as the "Las Vegas of China" because its gambling industry has been growing at an incredible pace. By 2006, Macau had become the world's biggest gambling center, upstaging Las Vegas itself.

In a couple of recent articles, one from this summer and the other from October, my colleague Marshall Hargrave illustrated the phenomenal rise of Macau's gaming industry. He also provided excellent stock tips for those who wish to capitalize -- and I've got another one for you to consider: a Macau-based subsidiary of a leading U.S. operator of casino resorts.

Since going public in October 2009, the subsidiary has seen its stock rise nearly threefold. Shares are up almost 70% during the past 12 months alone.

I'm a huge fan of the stock (and own a substantial amount myself) because it's a pure play on Macau, meaning it generates all its revenue there. This means there are no weaker-performing revenue sources to inhibit this subsidiary's overall performance, unlike what you might see with shares of a casino operator that does only some of its business in Macau.

I also particularly like that this subsidiary has a diversified customer base. That is, by providing plenty of private gambling tables, it attracts a large share of the wealthier VIP clients who account for so much of Macau's gambling action. Yet it also offers numerous slot machines and mass-market gambling tables for China's expanding middle class.

I'm referring to Wynn Macau (WYNMF), a subsidiary of Las Vegas-based casino giant Wynn Resorts (Nasdaq: WYNN) that opened for business in Macau in 2006. Although the stock has climbed a great deal already, I see even more upside in coming years.

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  Wynn Macau's 275,000-square-foot casino facility, which includes nearly 300 VIP gaming tables, has more than 200 mass-market tables and about 1,000 slot machines.  

Why? Wynn Macau is owned by Wynn Resorts, a venerable and respected name in casinos and entertainment. And though WYNMF trades over the counter, Wynn Macau is a large company in its own right, boasting a market capitalization of nearly $23 billion.

It does operate in an emerging market, though, so the stock price tends to be more volatile than the overall U.S. market. However, price swings are tempered somewhat by the $0.16-per-share dividend, which is good for a yield of 3.6% at the current price of about $4.50 a share.

Revenue growth has been enviable, expanding by an average of 19.7% annually from $1.8 billion in 2009 to nearly $3.8 billion this year. Although the growth rate could tail off somewhat during the next few years because of a softer Chinese economy, I expect Wynn Macau can manage an average yearly gain of about 15% on increasing business from the middle class. Thus, I expect revenue jump to at least fourfold from 2009 levels, to nearly $7.6 billion by 2018:

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The vast majority of revenue (about 94%) comes from a diverse mix of gambling activities at Wynn Macau's 275,000-square-foot casino facility, which includes nearly 300 VIP gaming tables, more than 200 mass-market tables and about 1,000 slot machines. The casino space operates 24 hours a day. The eight casual and fine dining restaurants and 55,000 square feet of high-end, name-brand retail space account for the remainder of Wynn Macau's revenue.

Although emerging-market stocks are often associated with extreme risk, Wynn Macau has shown a high degree of financial strength. For example, current assets (cash reserves and other liquid assets) total almost $1.7 billion, about double the subsidiary's short-term liabilities of $826 million. The debt-to-equity ratio is just 0.7, far lower than the industry average of 3.1.

At $727 million, free cash flow is higher than Wynn Macau's five-year average of $636 million. Net income has more than tripled the past four years, from $269 million in 2009 to $884 million now.

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Risks to Consider: Despite its addictive nature, gambling isn't immune to economic downturns. Any significant pullback in the global economy or the Asia-Pacific region where Wynn Macau does business could take the wind out of the company's sails. And there's always hot competition, like another Macau pure play, Melco Crown Entertainment (Nasdaq: MPEL) (which my colleague Marshall profiled earlier this year), and major casino operators with a presence in Macau such as Las Vegas Sands (NYSE: LVS).

Action to Take --> Although I wouldn't be surprised if global markets corrected sharply during the next several months, I think we're headed for much better long-term economic growth. Thus, analyst projections for Wynn Macau 's earnings per share (EPS) to climb an average of 15% a year, from its current $0.17 to $0.34 in 2018, could be on the conservative side -- particularly since gambling's popularity is expected to continue rising among the Chinese middle class.

If I'm right, then now is an excellent time to buy Wynn Macau. Shares could easily double in five years along with EPS because investors could well keep paying about 28 times earnings in a strong global economy. And if estimates for EPS growth turn out to be on the low side as I suspect, the stock could gain substantially more than I've suggested here.

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