China Reopening Follow-Up
Welcome to Mule's Musings - Let's get cooking
First, if you find this helpful, the newsletter is tiny right now. I plan to unlock most of these posts eventually but on the max time amount possible. I would love for you to share it - I think I have a lot of great ideas right now, and I want to share them! I want to write more about Fragrances, a trade I discussed in Trend Watch #1 - worth reading.
The company that has my eye there is COTY, which looks like a brutal incremental profitability model. I will model it out and see what they truly can earn. But that’s for another day; today, we need to focus on China’s reopening.
China Reopening is Accelerating
The first piece of news is that China’s PMI accelerated in a way no one saw coming. This is good for semiconductors (joking). PMI above 56 is staggering.
The Purchasing Managers Index (PMI) is a critical economic indicator that measures the purchasing activity of businesses in a specific industry or region, in this case, China. PMI matters because it correlates strongly with business activity levels. A high PMI signals increased demand for goods and services, which can boost economic growth and employment. In contrast, a low PMI may indicate a contraction in economic activity. Readings below 50 are considered a contractionary period.
China’s composite PMI exploded. That means industrial activity is back. That’s very good for the reopening trade I explored in the first post announcing this substack.
But moreover, it’s not just industrial data that is rebounding, but flights in particular, are accelerating at a pace many didn’t expect. This is a piece from RBC; local travel and daily transit are already north of 100%, many even at 115%. The 115% case for Casinos that I outline looks to be the base case, not the bull case.
For example, RBC thinks total flight activity will be 115% of 2023, just two months into 2023. Airlines are already starting to add capacity, Rolls Royce will benefit, and the hermit kingdom finds itself abroad again. The revenge spending will be massive. I think it’s clear that the rate of change is still being underestimated, and the names I outlined in the piece above are still fair, if not undervalued. I want to reiterate that my best ideas are in the post above.
But let’s also turn to some specific companies and their call-outs for foot traffic, in this case, Melco and Galaxy holdings. Both had strong earnings, but some of the commentaries were perfect.
Melco Earnings
The standout in Melco’s earnings is there is operating leverage.
The kind of cool thing that Lawrence mentioned for us as well is that where we were back at the end of the fourth quarter of 2019, we're going to have approximately 10% less FTEs at the end of 2023 when everything is opened for Phase 2 with all our properties in Macau.
Operating margins, without a doubt, will see new cycle highs, and Melco should do the 30s. Imagine a world with 10% fewer FTEs with a larger footprint.
And so I think with the recovery now, we hope to have meaningfully -- we hope to have meaningful flow-through to the bottom line. And that is the focus of this company, we care about EBITDA and cash flow more than we care about anything else.
February was amazing. It is as good as CNY and had fewer days.
Joe, well, I think if you look at February, February had 10% less days than January. And the figures that DICJ and Macau government released today was effectively February and January were flat. And considering that Chinese New Year, the entire Chinese New Year period, was really in January this year. So when you take out -- when you look at all of that, January -- I mean, February was an amazing month.
They are already at 70% visitation of 2019 and given that Sands Singapore is doing 115% of 2019 gambling spend on 70% visitation, that’s very good for casinos.
Galaxy Holdings
They have already achieved 2019 levels in mass.
We -- as far as our performance, we actually achieved our 2019 GGR for Chinese New Year in Mass
There isn’t much more, but things are good in Macau.
I want to leave you on another note because there is another very janky reopening name I was remiss to mention in my other piece because of the company's size, and that’s IMAX. I know the first reaction is terrible, but let me explain.
Another Reopening Idea: IMAX
IMAX had the second-best day for Chinese New Year’s ever, which put it on my radar as a reopening stock. IMAX had 639 of its 1409 theatres in China in 2018, making approximately ~31% of its revenue.
Now China is only ~24% of its revenue, compared to 44% in 2021 and 38% in 2022. But now, 794 of its 1633 theatres are in China, 48% compared to 45% of theatres.
Besides the outsized Chinese revenue with some operating leverage, the part that makes this story interesting is that the slate of films is different. The big difference is there were virtually no local language films before this year, and it’s already material.
IMAX delivered its best Chinese New Year holiday ever for local language films with $61.3 million in total box office receipts well over our budgeted projection of $42 million. And our lead title, Wandering Earth 2, is now our highest grossing local language film of all time. Furthermore, key Hollywood tentpoles are again securing day-and-date releases in China, including the Marvel franchise, which returned to cinemas this past weekend for the first time since 2019.
And what’s more, Marvel movies are finally set to return to China, which hasn’t happened in 4 years. That’s another lever for IMAX. I think the naive assumption that IMAX will get back to 2019 levels in China is wrong, and instead, with the slate of local films and a larger footprint, IMAX should exceed its 2019 revenue easily.
That nets me more than $1.00 of earnings, with another 10-20 cents in outperformance possible if there is a hard reopening and China overperforms with the new local language films.
Pre-COVID IMAX traded at ~25x earnings, and if they were to see $1.20 from a larger Chinese footprint, increased operational leverage, and new local language films, I think the bull-est of cases could see $1.20 x 25 = $30.
In reality, I think it’s safer to play for the low 20s. I think this one is interesting but not as attractive as the others. The local language aspect has a real lever that makes it hard to understand what IMAX could earn in the future. But it should be higher than in 2019.
I leave you with a parting question. Which paragraph was co-written by GPT in this article? Comment your thoughts on the reopening trade and other reopening ideas below.
My guess on the paragraph that was co-written by GPT is the one where you explain PMI.