Casino stocks are a bad bet
Posted
Sep 22 2009, 08:44 AM
by
Minyanville
Rating:
This article is written by Minyanville's Josh Lipton
Investors have wagered hard on the gambling stocks but, at their current prices, it’s hard to see why stock pickers should double down on this bet. Jeff Macke vibed on this sector over the summer in, Don't Gamble on Casino Stocks.
Wynn Resorts (WYNN) made headlines over the weekend when the Las Vegas-based company said it has increased the size of the initial public offering in Hong Kong for its Macau unit by 25%, looking to raise up to $1.6 billion, according to Reuters. Wynn’s rival, Las Vegas Sands (LVS), is also busy, hoping to raise $1 billion to $2 billion through the sale of a stake in its Macau operations, possibly at the end of November.
Investors have gone all-in with the gambling stocks: Over the last six months, Wynn is up 232%, MGM Mirage (MGM) has skyrocketed 329%, and Las Vegas Sands has surged 673%.
Why the enthusiasm? The stocks have run off the bottom as investors bet on better times ahead for the consumer. Also, there's now less fear about these companies going belly up.
However, casino analysts remain cautious, for good reason.
Yes, Macau is showing signs of improvement, but Sin City still confronts a range of challenges -- and those hard headwinds, coupled with unattractive valuation, make it hard to see how the gambling industry is a smart bet right now.
One reason for optimism about the casino operators: Analysts note that these companies, while highly leveraged, have worked hard to strengthen their balance sheets.
“A lot of these companies have very stressed out balance sheets,” says Robert LaFleur, casino analyst at Susquehanna Financial Group. “As a result of refinancing activity and some equity raises, they have gotten into much better shape recently.”
There's also been better news lately out of Macau, analysts say, with an easing in visa restrictions so more gamblers can spend their paychecks at the slot machines and blackjack tables. Macau is China’s only gaming destination, and it benefits from the booming middle class and high population density in that area of the world, notes Morningstar analyst Michelle Chang.
Macau is within a three-hour flight of more than one billion people and a five-hour flight of more than three billion people. Little wonder then that Macau surpassed the Las Vegas Strip as the largest gaming market on the planet.
The growth in Macau is positive news for casino operators with exposure to the area, such as Wynn Resorts and Las Vegas Sands. However, domestic gambling companies like MGM, which are more dependent on Vegas than far-flung Macau, face potentially tougher times.
“Las Vegas still has numerous problems it has to deal with,” LaFleur tells Minyanville. “Visitor volumes to the city have returned to normal levels from some of the displacement in the fall but room rates, which are a key contributor to profits for Las Vegas operators, are very low.” The analyst adds, “Also, there is a series of properties opening up toward the end of the year, which adds supply to the market. So we have a very soft room-rate environment right now with the potential for new supply coming online.”
LaFleur mentions an additional worry: It remains to be seen how strongly the important convention business snaps back.
“Prospects are better now than they were six months ago, but it is hard to judge based on the past couple months because the summer isn’t a big convention time in Vegas,” the analyst says.
As for American consumers, while they will always seek out a night of entertainment, it’s hard to imagine them spending money like they once did any time soon. After a generation of go-go spending and borrowing, consumers have rediscovered the merits of prudence and thrift.
Gary Shilling, of A. Gary Shilling & Co., notes that many Americans have maxed out their credit cards as lending standards tighten and delinquencies mount. Meanwhile, he says, widespread layoffs persist, benefits have been trimmed, and finding new work for the jobless is extremely difficult.
The net effect of all this bad news? The consumer has had no choice but to retrench -- hard. The average savings rate rebounded from about 1.7% in August 2008 to 5%, according to the Bureau of Economic Analysis. Shilling forecasts an average one percentage point rise in the savings rate annually, raising it to 10% in 10 years.
It makes sense that Americans would be more interested in repairing their personal balance sheets than playing poker, but that isn’t good news for companies in the gambling industry. Revenue per available room in Vegas will likely be $77 in 2009 versus $119 in 2007, estimates Bill Lerner, an analyst with Union Gaming Group.
Finally, turning to valuation, gambling stocks are looking pricey, at least when judged by certain measures: The sector now trades at 24.33 times expected earnings over the next 12 months versus 15.08 for the overall market, according to Bloomberg data.
For those investors that want to carve out positions in the industry, a better bet could be to try and find opportunity among the regional operators, says LaFleur.
“The regional gaming markets have been performing better than destination-oriented markets like Las Vegas and Atlantic City,” he says.
For example, LaFleur is telling his clients to commit capital to Isle of Capri Casinos (ISLE), a Missouri-based company with a market cap of about $380 million.
“It has a very good cash flow generation outlook, and we expect the company to prudently deploy capital,” he says. “It is the one we’re comfortable recommending.”
No positions in stocks mentioned
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