Wynn Resorts: Demand Destruction & Debt Lead To Disaster (WYNN)

Conviction is a powerful thing. It is over-utilized in stock market analysis, and even more so in how investors manage their portfolios. Facts are facts, they simply are and believing in them requires no conviction. Within a well-structured framework it can be an asset, but as an overriding mechanism conviction is many investors’ greatest weakness.

Over the long term, every stock overextends in both directions and experiences various inflection points. As investors, our winners often run farther than we expect and our losers do the same. In order to avoid riding losers all the way down, well educated investors use stop losses without exception. They may employ them in vastly different ways, however, the idea of holding on to a losing position till the bitter end is never a sound investment strategy.

Few, if any, names inspire as much conviction as Tesla (TSLA). TSLA short interest peaked in 2016 at 25%, with the share price well under $20. By July 13, 2021 it had fallen to 4.4%, the stock trading at $215 per share. 4 months later, TSLA made an all-time high over $400 per share. By then, shorts had been further squeezed and short interest had fallen to 3.5%. On the way down to the current share price (at time of writing), $123, short interest has remained steadily around 3%, never again exceeding 3.5%. TSLA short sellers, as a whole, lost much more money shorting the stock in years prior than they made in 2022. Many of the highest conviction TSLA bears experienced maximum pain via losses, margin calls, or puts expiring worthless one too many times. John Maynard Keynes might say the market remained irrational longer than they remained solvent.

Conviction is more typically punished on the long side of things and in less dramatic fashion. My inspiration to write this article came from an episode of CNBC’s Fast Money. In it, Jeff Mills referred to major airline stocks as mere “trading vehicles,” with Guy Adami declaring them “dead money for the last 20 years.” When I hear “trading vehicle,” I think “market makers enacting a controlled demolition.” Conviction, it seems, is all that can explain any investor holding AAL stock for the long term.

From 2008-12, more than a handful of Chinese companies I had been following were exposed as massive frauds by Muddy Waters and the like, resulting in their delisting. Having followed their charts unsuspectingly for years prior, my takeaway was that the trading activity I had witnessed was, in fact, controlled demolition. American Airlines (AAL) 10-year chart gives the same eerie vibes of a ceiling continually being lowered. Over the short term of up to a few months, these assets typically perform similarly to higher quality names, but with weaker intraday action. Longer term, the charts are broken, with price and volume well below all-time highs. Another sign of a “trading vehicle” is illiquidity. If the bid-ask spread is unusually wide for the share price, do not necessarily run but to be particularly wary.

Given the high degree of uncertainty that defines equity markets to start 2023, an appealing strategy is to take a market neutral stance and focus short term on “trading vehicles” rather than higher quality names. American and United (UAL) are characterized by high debt ratios, execution challenges, demand sinkholes and commodity risk to the downside, and a potential monopolistic merger to the upside. Their debt-to-equity ratios, both in excess of 2.5x, are death sentences. With interest rates on the rise, heavily indebted companies without high margins or growth will struggle to pay bond holders, and struggle even more to raise additional money on serviceable terms.

Unfortunately, AAL & UAL lack the volatility that creates sizable swings. A company in an earlier stage of controlled demolition, ripe with conviction to bleed, is Wynn Resorts (NASDAQ:WYNN).

Since early December, China reopening has been a major theme and equities perceived to benefit have rallied hard. Wells Fargo (WFC) upgraded WYNN on January 3, as JPMorgan (JPM) did in late November, with the primary catalyst cited being China reopening. In part due to China’s restrictive zero COVID policy, Macau gaming revenue fell 51% in 2022 from 2021. In 2021, with casinos open, WYNN lost $6.64 per share. Profitability is nowhere in sight.

Shares of WYNN are now up over 60% from lows made in October. How much farther can they run based on a China reopening that has not included a pick up in economic activity?

The mantra is that WYNN will pick up where it left off in 2019. Have investors lost sight of how direly Western relations have soured with China, simply because they are even worse with Russia? Regardless of why, China has lost trust from much of the West since the COVID pandemic began. The number of people with plans to travel there has surely fallen off a cliff. Global travel and entertainment budgets, too, have been crippled by inflation and WYNN depends entirely on the most economically sensitive part of each customer’s budget. Local “whales” playing baccarat and short deck poker may account for a greater share of Macau activity than that in Las Vegas, but the type of activity WYNN needs to turn a significant profit is not in the cards.

To operate in Macau going forward, Wynn and other proprietors must pay local authorities annual utilization fees described here. The fees are based on square footage and were determined prior to 2020, when casino traffic was much higher. WYNN will owe tens of millions of dollars per year starting March 2023, and for years 4 through 10 the fee is 250% higher.

WYNN is a global travel and leisure play with negative margins, questionable growth and a debt to equity ratio of 1.35. Just for perspective, debt-to-equity ratios across the board include AAPL at .06x, General Electric (GE) at .22x, Booking.com (BKNG) at .11x, Hilton Hotels (HLT) at .26x and Las Vegas Sands (LVS) at .36x. Additionally, each of those names operate at a profit while WYNN hasn’t done so since squeezing out $1.15 in EPS for 2019.

WYNN traded on much higher volume at much higher prices for most of 2010-2019 than it does today, so the stock trades without significant resistance (or support for that matter). From its inception, however, the long-term chart is one big head and shoulders pattern.

On January 4, WYNN shares rallied to 10-month highs, peaking at $92.35 and closing at $90.90. I added to my short position, which now sits at 2/3 its limit. The trading day struck me as a bearish “dash for trash,” as market leading banks and tech finished up but well off highs, and the best performers included WYNN, AAL, Coinbase (COIN) and other highly shorted names with completely broken charts.

A break for WYNN above $96.50, the 2022 high, would stop me out of this trade and likely bring a technical move much higher. If that move were to carry on past $200 per share, my thesis would be demolished along with the aforementioned head and shoulders call. I’m currently looking to cover in the low $70s, and if the stock were to tumble as low at $60 my bias would be to go long for a bounce to the high $60s.

Shares of WYNN are volatile and risky to hold in either direction. I would only recommend shorting the stock to someone who keeps a close eye on the market and is comfortable employing a stop loss. More certainly, long term investors are faced with a prime window of opportunity to exit WYNN and rotate into other companies offering growth, value and/or income.