Are These Casino Stocks A Good Bet?
Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There are no compelling casino stocks at current prices. There are several attractive growth stories, but investors should wait for lower valuations before placing their bets. Anything over a 15x multiple is high for casino stocks, which are highly cyclical and face both regulatory risk and stiff competition, in addition to higher taxes. Multiples (in the 20s) should be afforded to stalwarts like Smuckers (SJM), not cyclical gaming companies.
None of these firms is a screaming buy:
Shares of these stocks, with the exception of MGM (NYSE: MGM), are trading at high earnings multiples. In terms of revenue multiples, only MGM and Royal Caribbean (NYSE: RCL) are attractive. Only Royal Caribbean seems to be trading at an attractive discount to its book value.
Macau Casinos Beat the Odds
One compelling growth story in gaming is the growth potential for casinos in Asia. December was a very lucrative month for casinos in the region, beating conservative analyst estimates who feared reduced spending from a Chinese soft landing.
Macau’s casinos recorded a 20 percent rise in revenue, beating expert forecasts for the month of December. This rise is attributed to the festive promotions which attracted tourists to casinos. Statistics released from Macau’s Gaming Inspection and Coordination Bureau indicates that revenues for Macau gaming had risen to $3.5 billion in December, compared to $3.4 billion in October. This revenue growth has helped to catapult the shares of Sand China to an all-time high.
Jeremy Tan, a Hong Kong- based analyst at Kim Eng Securities said, “This is definitely better than our expectation, and much higher than the street estimates. It’s a combination of higher holiday footfall, higher win-rates, and a return to the VIP market.”
Revenue collected from gambling on the rise mainly because operators like Galaxy Sands China and Melco Crown Entertainment have been expanding in the only region in China where casinos are legally allowed to operate. Another factor that has contributed to the increase in casino revenue is the spending habits of the middle-class Chinese tourists, even though the upper class citizens have cut down on their spending.
Yes, a broader demand for gaming is encouraging.
However, investors should refuse to pay for future earnings growth since the threat of competition from the next, fancier resort or casino is a perpetual threat. Galaxy, owned by Hong Kong business tycoon Lui Che-Woo, plans to build a resort on Macau at a cost of almost $7 billion. Construction is set to begin late 2013, and the project will cover almost 10 million square feet. This is double the size of the already existing resort. Clearly, more capacity is being developed, and that is a bad sign for profitability.
Wynn and Okada Go the Distance
International operations also bring their own special challenges. Relations between regulators, partners, suppliers, and customers can sour. Legal issues can become more complex when they involve multiple domiciles.
One example of a major beef between ex-friends and business partners is being played out between Wynn Resorts (NASDAQ: WYNN) Chairman Stephen Wynn and Kazuo Okada. Mr. Wynn is pushing for the removal of Kazuo Okada from the casino company’s board. Wynn and Okada have had major disagreements in the past year, and Wynn now seeks a two-thirds shareholder vote to remove Okada. Though a date is yet to be set for the special shareholder meeting, the company already seized Okada’s $1.9 billion stake.
Part of the discord between Wynn and Okada resulted from a casino project in Philippines proposed by the Okada that the company declined to invest in. Okada later on found a billionaire partner for the $2 billion project. Okada also voted against a $135 pledge to a foundation that was proposed by Wynn.
Okada’s proposed removal is only one of the many changes expected in the board of Wynn Resorts. Two directors, Russell Goldsmith and Allan Zeman, resigned to focus on their other businesses, while Linda Chen and Marc Schorr stepped down. The company also expects to reduce the number of board member from twelve to nine. According to Wynn, “By streamlining the board and eliminating an unsuitable director, the company will be well positioned to capitalize on the enormous opportunities in the market and execute our ambitious expansion plans.”
Another casino growth story is comes from a tax avoidance strategy. Penn National Gaming (NASDAQ: PENN) announced it will spin-off its real estate assets as a real estate investment trust (REIT). Real estate investment trusts avoid federal income taxes and are instead required to distribute a minimum of 90 percent of taxable earnings to shareholders. Penn National Gaming may have kicked off the next capital structure trend in the gaming sector. The company has received approval from the IRS and needs no further approvals. Penn National Gaming Chairman and CEO Peter Carlino said, “This process will unlock the tremendous value of our real estate portfolio. This is just strictly our view of how we can best take the assets we have and make the most of them.”
The industry could benefit from REIT conversion, but investors should not pay a premium for such a possibility. As more industries adopt REIT classification, the government may crack-down on these entities to boost revenues. Moreover, many firms that have yet to announce a REIT conversion may be fight this trend as they involve a split-off or a spin-off, which can reduce management control and prestige.
The growth stories in Asian gaming growth and REIT conversion are nice, but they are not something investors should be willing to pay premiums for. Instead, they should wait for lower price multiples.
BillEdson11 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!