Should You Play The Rush?

Dan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Analysts despise Caesars (NASDAQ: CZR). At the same time, the stock has appreciated more than 100% year to date. Obviously, something doesn’t add up--either the analysts are wrong or the stock is ahead of itself. We’ll try to figure it out, but first let's take a look at the industry as a whole for some background. 

Industry trends

Casino operators rely heavily on industry trends. If you look at all the companies in the industry, you will notice that most of the stocks trade together. Recently, these stocks have appreciated for several reasons.

In 2012, more people visited Las Vegas than in any other year in history. Approximately 39.7 million people visited Las Vegas last year, representing a 2.1% increase over 2011. This led to more than $40 billion in revenue for the industry, and $9.4 billion in gaming revenue for Clark County. The latter was a 1.9% improvement over 2011. More specifically, gaming revenue on the strip jumped 2.3%. Furthermore, the average daily room rate moved $3 higher to $108 per night, and the hotel occupancy rate of 84.4% exceeded the occupancy rate for any other city in the United States.

Another plus has been a rebound for the convention industry. Tradeshows and conventions jumped 13.6% year over year, and convention attendance rose 1.6%.

Perhaps the most exciting prospect for the industry is the potential of online gambling . Online gambling is already legal in Nevada, but it’s limited to poker, which has led to estimates of $50 million to $250 million in annual revenue potential. In New Jersey, these estimates are much higher at $500 million to $1 billion, because online gaming isn’t limited to poker.

In the Garden State, licensure is limited to 12 land-based casinos. Caesars was sure to get in on the game early, especially after it missed out on Macau. Online gaming in New Jersey is expected to become a reality as early as November of this year. Caesars has partnered with 888 Holdings in preparation for this event.

Saturation

While online gaming potential is good, and it’s driving many stock prices higher, a problem exists in the real world. United States casinos are reaching a saturation point, if they’re not there already. If you plan to visit Las Vegas, then you’re going to have dozens of options to choose from, and that’s just on the strip. When there are so many options available, it hurts revenue potential for any specific company. And even if that company owns more than one property, it’s competing against itself, which will hurt the bottom line.

Atlantic City is also oversaturated, and since Pennsylvania casinos opened in 2006, Atlantic City revenues have been cut in half. New resort casinos like Revel might seem as though they would help the industry, but these openings simply lead to declining margins for nearby locations.

The only solution is for underperforming casinos to close. Perhaps the companies that miss out (or don’t perform well) online will be forced to close physical locations, which would then greatly help neighboring properties. It’s also possible that one or more companies perform so well online that they close their physical location(s), which would also help neighboring properties.

The problem is that once a casino implodes in Las Vegas or Atlantic City, another property is built. The only solution is for a savvy casino owner to buy the property and turn it into a non-gaming form of entertainment. Even a parking lot would help. 

The big picture

Las Vegas is likely seeing increased visitation because consumers are weaker than in years past. A weak consumer can’t afford an all-inclusive vacation to the Bahamas or a 5-star hotel in Manhattan. Las Vegas offers discounted hotel rates because they aim to make back the missed revenue in gaming, but gaming revenue is more spread out than ever before due to oversaturation. This is part of the reason Caesars can’t turn a profit, even when Las Vegas visitation is at an all-time high. 

Revenue and earnings for Caesars have declined since 2008, which is extremely rare for any company in any industry. Revenue and earnings saw slight pops in 2011, but they declined again in 2012. Caesars has reported losses over the past three years, and while the loss narrowed in 2011, it widened in 2012.

Boyd Gaming’s (NYSE: BYD) revenue has increased over the past three years, but it has reported losses in the past two, with a substantially widened loss in 2012. Boyd Gaming owns the Borgata in Atlantic City, which is widely known as the top location in Atlantic City for gamers, but its Las Vegas properties are known as second-tier compared to other available options. Boyd also has some unflattering numbers, including a profit margin of -35.58% (which demonstrates poor efficiency) and a debt-to-equity ratio of 9.57 versus an industry average of 3.3 (a large debt load impedes growth potential). Boyd's stock might continue to perform well in the current all-stocks-in-bull-mode environment, but long-term stock appreciation will be difficult to achieve. 

MGM Resorts (NYSE: MGM) has seen revenue increases over the past three years, but though there was a profit in 2011, MGM reported losses in four of the last five years. MGM owns a profit margin of -17.41%, but while it's debt-to-equity ratio is high at 1.74, that's still better than the industry average. MGM is also a household brand name, which gives it value even in the worst of times.

MGM doesn't look to be an ideal investment at this time based on underlying fundamentals, although momentum may carry the stock higher in the near future. Long-term investors should consider waiting for a better price in the future. 

From a fundamental standpoint, none of these companies are impressive. All three sport negative profit margins in the double digits, and all three companies are highly leveraged, which will impede growth potential. MGM is the largest company of the three, making it the most resilient, and it has significant exposure to Macau, which gives it the best long-term potential. However, all three would be extremely high-risk investments at this time.

Conclusion

Nobody knows how online gambling will change the industry. The potential is high, but online gambling has a bad reputation for cheating, as well as difficult withdrawal options. If large companies enter the environment, then it’s likely that these fears will dissipate. If these companies win the trust of online gamers, then the sky is the limit; online costs are much lower than brick and mortar costs. It has the potential to be a home run, especially if more states get involved.

On the other hand, physical casino properties must be reduced in order for sustainable growth to become a reality. It’s the only solution. Hopefully, one of the more powerful businessmen in the industry will eventually recognize this and do something about it.

As far as Caesars goes, it looks to be a strong momentum play based on upside potential for online gambling. However, this is a highly leveraged company, and there are no guarantees. If the online experiment is a failure, then all bets are off. 

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Dan Moskowitz 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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