Zions Bancorporation & MGM Resorts

Sixteen new stocks made the Most Attractive list this month, while fifteen new stocks joined the Most Dangerous list.

May Performance Recap

The Most Attractive Stocks (-0.1%) underperformed the S&P 500 (+2.2%) last month by 2.3%. The best performing large cap stock gained 13% and the best performing small cap stock was up 47%. Overall, 14 out of the 40 Most Attractive stocks outperformed the S&P 500.

The Most Dangerous Stocks (-4.0%) outperformed the S&P 500 (+2.2%) as a short portfolio last month by 6.2%. The best performing large cap short stock fell by 17% and the best performing small cap short stock fell by 32%. Overall, 21 out of the 28 Most Dangerous stocks outperformed the S&P 500 as shorts.

The Most Attractive/Most Dangerous Model Portfolios outperformed as an equal-weighted long/short portfolio by 3.9%.

The Most Attractive stocks have high and rising returns on invested capital (ROIC) and low price to economic book value ratios. Most Dangerous stocks have misleading earnings and long growth appreciation periods implied by their market valuations.

Most Attractive Stocks Feature for June: Zions Bancorporation

Zions Bancorporation is the featured stock from June’s Most Attractive Stocks Model Portfolio.

Zions has grown revenue by 6% compounded annually and net operating profit after tax (NOPAT) by 21% compounded annually since 2012. Zions’ NOPAT margin increased from 10% in 2012 to 38% in the trailing twelve months (TTM), and invested capital turns rose from 0.3 to 0.4 over the same time. Rising NOPAT margins and invested capital turns drive Zions’ return on invested capital (ROIC) from 2% in 2012 to 15% in the TTM.

Figure 1: Zions Revenue and NOPAT Since 2012

Zions Is Undervalued

At its current price of $31/share, ZION has a price-to-economic book value (PEBV) ratio of 0.3. This ratio means the market expects Zions’ NOPAT to permanently decline by 70%. This expectation seems overly pessimistic for a company that has grown NOPAT by 18% compounded annually since 2017 and 21% compounded annually since 2012.

Even if Zions’ NOPAT margin falls to 20% (compared to 38% in the TTM) and the company’s revenue grows just 1% compounded annually through 2032, the stock would be worth $60/share today – an 87% upside. In this scenario, Zions’s NOPAT would decline 6% compounded annually through 2032. Should Zions grow profits more in line with historical levels, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I made based on Robo-Analyst findings in Zions Industries’ 10-Qs and 10-Ks:

Income Statement: I made $117 million in adjustments, with a net effect of removing $94 million in non-operating expenses (2% of revenue).

Balance Sheet: I made $6.9 billion in adjustments to calculate invested capital with a net increase of $4.0 billion. One of the most notable adjustments was $3.1 billion in adjustments for other comprehensive income. This adjustment represents 46% of reported net assets.

Valuation: I made $670 million in adjustments, all of which decreased shareholder value. The most notable adjustment was $440 million in net value of preferred capital. This adjustment represents 9% of Zions’ market value.

Most Dangerous Stocks Feature: MGM Resorts International

MGM Resorts (MGM) is the featured stock from June’s Most Dangerous Stocks Model Portfolio.

Though MGM Resorts revenue grew 5% compounded annually from 2017 to the TTM, the company’s NOPAT margin fell from 14% to -4% and invested capital turns remained unchanged at 0.3 over the same time. Falling NOPAT margins drive MGM’s ROIC from 5% in 2017 to -1% over the TTM. MGM’s economic earnings, the true cash flows of the business, have fallen from $-830 million 2017 to -$3.9 billion in the TTM. See Figure 2.

Figure 2: MGM Economic Earnings Since 2016

MGM Provides Poor Risk/Reward

Despite its poor fundamentals, MGM’s stock is priced for significant profit growth, and I believe the stock is overvalued.

To justify its current price of $42/share, MGM must improve its NOPAT margin to 10% (5x its five-year average) and grow revenue by 11% compounded annually for the next decade (compared to 4% compounded annually over the past decade). In this scenario, MGM’s NOPAT in 2032 would equal $3.6 billion, or more than 2x its highest-ever NOPAT, achieved in 2019. I think these expectations are overly optimistic.

Even if MGM improves its NOPAT margin to 8% and grows revenue and 9% compounded annually for the next decade, the stock would be worth no more than $7/share today – an 83% downside to the current stock price.

Each of these scenarios also assumes MGM can grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows me to create best case scenarios that demonstrate the high expectations embedded in the current valuation.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I made based on Robo-Analyst findings in MGM’s 10-Qs and 10-Ks:

Income Statement: I made $7.3 billion in adjustments, with a net effect of removing $2.1 billion in non-operating income (15% of revenue).

Balance Sheet: I made $25.8 billion in adjustments to calculate invested capital with a net increase of $858 million. One of the most notable adjustments was $6.3 billion in asset write-downs. This adjustment represented 15% of reported net assets.

Valuation: I made $35.6 billion in adjustments, with a net decrease to shareholder value of $27.1 billion. The most notable adjustment to shareholder value was $4.0 billion in operating leases. This adjustment represents 26% of MGM’s market value.

Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.