The Good & Bad About Casino Stocks

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Casino companies have been on quite a run over the past few months. With multiples already high, the last thing you want to do is buy at the end of the bull run--even if the long-term prospects are bright. I recommend looking at whether the business is cheap relative to its discounted growth trajectory and then making an investment decision based on any upside from there. Below, I review several stocks in the business with this in mind.

Las Vegas Sands (NYSE: LVS): The Good & Bad

As the premier casino operator, LVS is able to command a premium at 17.9x forward earnings. Analysts forecast 22.1% annual EPS growth over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $4.77. At a multiple of 15x, this translates to a future stock value of $71.55. Discounting backwards by 10% yields a present value of $44.43--right around the current market assessment. Analysts are still more bullish with a reflective $62 price target by Imperial Capital on the Street.

There are several headwinds, to be sure. Wells Fargo argues that poor gaming business for Genting Singapore in the third quarter suggests softening demand. Indeed, LVS report weakening business in Singapore and a lower hold rate in the region's Marina Bay Sands. Meanwhile, in Macau, expenses have come in higher than expected. The combination of these headwinds resulted in the company missing EPS by 13 cents on $0.46.

Though free cash flow has recovered sharply form the 3Q08 trough where $3.6 billion (ttm) was lost to three years later where was $1.4 billion was gained, the yield is still very weak at 3.6%. Return on invested capital of 8.4% is also below the weighted average cost of capital, which means value is being lost. With that said, investments in future growth opportunities have yet to realize their returns.

Catalysts For MGM Resorts (NYSE: MGM), Wynn Resorts (NASDAQ: WYNN)

Wynn Resorts has leading exposure to Macau, which, over the years, has become 5.5x the size of the Las Vegas Strip ($33.6 billion in 2011 gaming revenue). Wynn investors look forward to the 2016 planned opening of a resort in Macau's hottest destination, Cotai. LVS, Melco, and Galaxy are already established in the region, so a strong gambling foundation is just waiting for Wynn to unleash massive growth. The resort could be upwards of $4 billion and will have 500 gaming tables, 2000 hotel rooms, 10 restaurants, and several extras.

JPMorgan recently released a report that called Wynn Resorts "seriously undervalued" and a $133 stock. At 18.6x forward earnings and 15.2% annual EPS growth over the last 5 years, Wynn is on a solid track record towards creating value.  Indeed, the company is expected to grow EPS at the fastest annual rate (32.3%) among its six-strong peer group over the next 5 years. The casino operator already generates ROIC of 13.6% and hasn't even seen the fruits of its Cotai development.

By contrast, MGM Resorts is really struggling. Over the last 5 years, nine-tenths of shareholder value has been erased with no recovery in sight. Free cash flow (ttm) generation has hovered around $640 million over the last 36 months, but it is now yielding 13.6% from lost investor confidence. The stock has fallen 32.3% from its 52-week high, but the price-to-book ratio stands at just 0.9x. Analysts have also called the resort & casino operator massively undervalued. Cantor Fitzgerald has a $14 price target out on the stock--Brean Murray and Stifel Nicolaus are even more optimistic at $17 and $20, respectively. With the stock just at around $10.10, there is thus major upside.

In my view, MGM could possibly be a takeover. EPS is expected to recover to -$0.55 next year, and an acquisition ahead of profitability would take advantage of the aggressive market risk discounting. I encourage thinking like a suitor and buying now to take advantage of this potential play.

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