Gambling on Casino Stocks: Feelin' Lucky?
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Over the past three months, shares of the four largest publicly-traded casino companies have all plunged between a quarter and a third, while the broader market's gains and losses came out to a wash. After such a cold streak, is it time for gaming stocks to heat up? No card counting or lucky charms required to see that incumbent casino operators are looking like good bets. The most established companies boast high profit margins, expect strong earnings growth from booming Asian properties, and enjoy the protection of the considerable barrier to entry of government regulation of gambling.
The most important recent global development in gambling has been the partial opening of the Macau casino market in 2002. The small island, a former Portuguese colony, has since become the world's largest and fastest-growing gambling market, but only six companies have licenses to operate casinos in Macau. Their oligopoly on gaming licenses, combined with the difficulty to build in dense, swampy Macau, guarantees them the lion's share of revenue growth in gambling. And growth will come: rising incomes in China bode well for discretionary luxuries like gambling excursions, and China is investing heavily in infrastructure to facilitate tourism to Macau. High-speed rail lines will bring in tourists comfortably and rapidly from major cities on the coast, and a new bridge will shorten travel time from Hong King from 4 hours to 30 minutes.
Of the four Macau licensees traded on American exxhanges, the largest is Sheldon Adelson's Las Vegas Sands (NYSE: LVS). Despite its name and image as a quintessentially Vegas company, Las Vegas Sands generates over 80% of revenue from Asia. Sands has lead the development of the Cotai Strip in Macau, luring gambling activity away from the area's downtown and into a newly built-up strip of marshland on the periphery of the island. Cotai's most recent casino, the Sands Cotai Central, as well as its next casino scheduled to open are both Sands properties, leaving the company in a dominant position on the Strip for much of this decade. The next competing property, the Macau by Wynn Resorts (NASDAQ: WYNN), won't open until 2016 at the earliest. Las Vegas Sands is also a pioneer in the Singaporean casino market, possessing one of only two licenses on the island. Las Vegas Sands is probably the firm best-positioned to capture growth in the Asian market, which in Singapore has been in the mid-teens in recent years, and topping 40% in Macau. Despite this, the company is priced for only modest growth, at 18 times trailing earnings and 12 times forward earnings.
The second-largest presence on the Cotai Strip is Melco Crown Entertainment (NASDAQ: MPEL), a less-experienced operator focusing exclusively on the Asian market. While it, too, stands to benefit from secular trends in the industry, Melco itself is less compelling than its peers. Melco is already losing share after Sands and Galaxy Entertainment opened up new casinos in Cotai, and Steve Wynn's excellent track record of operating high-end, high margin luxury casinos portends continued erosion after Wynn Macau comes online. Wynn, which generates 70% of revenue from Macau, was slow to enter Cotai, but the company will be aggressive in rectifying this mistake. Melco puts up lower efficiency and profitability metrics than its American-bred peers, so if Wynn will take market share from anyone, I would expect Melco to be first on the chopping block. Last week, Melco impaired it's ability to fight back in Macau by announcing a $580 million investment in a new casino property in Manila, financed primarily through debt. The Philippines is not as lucrative a market as Macau or Singapore, or even prospective markets like Taiwan or South Korea, which may legalize some gambling in order to boost ailing tax revenues. Tellingly, Las Vegas Sands and Wynn opted to keep their powder dry rather than bid for the Filipino contract.
MGM Resorts International (NYSE: MGM) has the smallest positioning in Asia, with its 51%-owned Chinese subsidiary contributing only 20% of revenue. This will grow, but the company's heavy concentration on the Las Vegas market is troubling for investors. On the plus side, MGM owns about a third of all hotel rooms in Las Vegas, and after years of decline the convention and tourism market is starting to show signs of life. MGM's dominant position in the hotel space should allow it to exert some pricing power and boost profitability.
However, other trends are against the company. Budget worries have led states to issue many new gaming licenses, and the growth in the American regional markets will reduce the incentive for gamblers to head to Vegas. After a spending spree over the past decade to establish an Asian presence and consolidate the Vegas hotel market, MGM is saddled with debt and won't be able to respond to new opportunities as ably as Wynn or Las Vegas Sands. As any good gambler will tell you though, there are the right odds for any bet. MGM may be a value play, with shares selling at a steep discount to its peers on a cash flow, earnings, or book value basis. Even a modest improvement in operational metrics should expand these valuation multiples, with significant upside for investors at these prices.
Highly volatile and tightly geared to economic stability in developed markets and continued income growth in Asia, casinos are anything but a safe bet. Add in a good dose of political risk, and the fact that earnings literally depend on a gamble—in the most recent quarter, Wynn saw revenue drop because its Las Vegas casinos had an unusually low win rate—and you've got a sector that screams “stay away” for stability seekers. But after weathering a recession, the major casino operators have come out the other side meaner, leaner, and looking cheap compared to their earnings potential. If you're the betting type, casino stocks like Las Vegas Sands might be one of the best games in town.
CatoMinor has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.
