The House Always Wins: Can Casino Stocks Follow Suit?

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It is often said that when it comes to gambling, 'the house always wins.' However, it can be true that buying casino stocks in a down market can yield solid long-term profits. The key, as with all investments, is to do one's research and choose wisely.

Not just in Vegas anymore

Regional gaming has been increasing in recent years, driven by states and other governing bodies that view the construction of new casinos as a viable way to stimulate the local economy and add new jobs. As a result, the barriers to gaming or casino construction are gradually being eased. While most of the casinos being built and opened throughout the country are similar to Vegas-style resorts, making a costly trek to Nevada unnecessary, what is becoming even more prominent are Internet casinos and the ability for gamblers to 'scratch the itch' from their own homes.

And just as the close-to-home games have proliferated, overseas gaming has recently received plenty of attention. One such success story is Macau, the "Monte Carlo of the Orient." Macau, just off the coast of China and a quick jaunt from Hong Kong, is the only part of China where casino gambling is permitted and has seen an impressive 12% to 15% annual growth in the last two years. This growth beats that seen in the U.S. market.

Big players

There are plenty of big names in casino stocks. Wynn Resorts (NASDAQ: WYNN) is often considered the 'gold standard' for Las Vegas casinos. In a slowly recovering economy, it has generated over a billion dollars in free cash flow in the trailing 12 months. Currently, the stock is at $136, off its high of $161, and far from the low end of a trading range at $95.

Wynn Resorts is also boasting some impressive financials. Its revenue growth has slightly outpaced the industry average of 3% and since the same quarter one year prior, revenues have slightly increased by 5%. The stock is up about 30% over the past year, outperforming the rise in the S&P 500 Index during the same period, and should continue to move higher despite the fact that it has already enjoyed a very nice gain in the past year.

Next would be Las Vegas Sands (NYSE: LVS). Like Wynn, the company has seen a free cash flow of $1.6 billion in the trailing 12 months. Currently, the stock is at $58, just under its 52-week high of $62, so one might not want to jump in too soon; rather, keep it on the radar. Once it nears its trading range low of under $40, investors might consider entry. With its smart strategy of paying down its debt before looking to expand, its movement into the Macau expansion was a smart move as previously stated. Shares of LVS rallied last week after the financial results for Macau were released. It also beat revenue forecasts and hiked its dividend by 5 cents.

Another name in this arena is MGM Resorts (NYSE: MGM). While MGM Resorts is heavily burdened with $13.2 billion of debt while only generating around $400 million of free cash flow each year, there are new reasons for investors to be excited. MGM Resorts International is planning a $2.5 billion development on Macau’s Cotai Strip. Specifically, MGM Resorts is planning the construction of a 1,600-room hotel/casino that is expected to be completed by 2016. The property will complement the already existing MGM Grand Macau resort. While the new development will cost MGM Resorts upwards of $100 million, it is expected to drive increased spending by customers throughout the resort and will likely pay off big in the future. According to Howard Stutz, columnist for the Las Vegas Review-Journal, "Analysts expect Macau gaming revenue to jump 18% this year, exceeding a record $38 billion in 2012."

Competition from online casinos continues to be a factor for these big players. However, there is good news for large brick and mortar operators. The problem with many online sites is that, as a whole, they have been tainted by criminal activity and shady operations. Most recently, seven Dutch online casinos were shut down due to allegations of money laundering. 

So which game to play?

So should investors place their bets - and if so, on who? Casino stocks do have some degree of predictability. However, net income growth rates are extremely inconsistent, are heavily dependent on the economy, and are also affected by unpredictable gaming revenues (or losses). Weather can be a factor, and so can business travel and leisure travel trends.

The first thing to consider is that almost all casinos are hotels first and foremost. This means that the stocks often behave like hotel stocks do; namely, they will possibly perform poorly when the economy contracts. In those cycles, hotel REITs will be selling property. Shorting these (hotels and casinos) is a good bet. Likewise, it is wise to get in at the bottom, when the economy begins to expand.

Another consideration is that when the economy is expanding, gaming revenue can be unpredictable, but as a rule, it will grow as well. This is largely because people have more dispensable income for 'fun.' Analysts might be able to peg revenue and growth quarter to quarter, but establishing a growth rate, PEG ratio, or other valuation metric is difficult. This does not mean investors should ignore it, merely consider it in a total strategy.

Due to their cyclical nature, casino stocks are trading stocks and are more difficult to buy and hold. Currently, the American economy is on the upswing. Hotel average daily rates, occupancy rates, and revenue per available room are all rising strongly. Thus, casino and leisure stocks will rise as well.

While growth continues in casino and gaming availability, as mentioned in Macau, MGM's expansion on the strip, and Wynn's planned $4 billion resort on the Cotai Strip, revenue will likely increase as well. All of these factors make considering Wynn, Las Vegas Sands, and MGM a good bet.

Macau has grown to five-and-a-half times the size of the Las Vegas Strip, with $33.6 billion of gaming revenue in 2011, and Wynn Resorts is perfectly positioned to capture the opportunity in the region. Is that reason enough for investors like yourself to consider investing in Wynn right now? The Motley Fool answers this question and more in our most in-depth Wynn Resorts research available for smart investors like you. Thousands have already claimed their own premium ticker coverage, and you can gain instant access to your own by clicking here now.

Bill Edson 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!

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