Has This Stock "Bottomed Out"?... And More Gambling Considerations

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

Casino stocks may trade at high multiples, but the growth curve ahead looks steep. To better gauge whether growth has been factored into the stock price, I recommend performing a PV analysis, cross-comparing multiples, looking at expansion opportunities, and eyeing the financial statements. Below, I try to provide a more broad perspective on 3 casino stocks.

Why You Should Buy Las Vegas Sands (NYSE: LVS)

LVS is one of my favorite expensive stocks on the Street. While its multiples are high, the growth trajectory is quite strong. The bears have made deceleration in Macau and a weak ramp up at Cotai Central out to be a long-term trend. I see it as more of a short-term reflection of an uncertain global environment that has seen the worst factored in. The stock has fallen in the trailing months ending 1H12--a "bottoming out"--such that the upside/downside ratio is now very compelling.

Based on research from Wells Fargo, there are still several risks to be mindful of. First, the Singaporean government is currently amending the Casino Control Act to (1) raise the maximum fine to 10% of gross gaming revenues, (2) tightening access to casino credit, and possibly a (3) visit limit for low-income individuals. Second, investors need to keep an eye on any signs of cannibalization in Asian business. If Macau ends up yielding returns below expectations, this is likely a sign of cannibalization.

However, I believe that the risks do not outweigh the reward. According to Melco Crown, the company has been rumored to be in discussion with banks about a possible expansion in Spain. This more diversified exposure to emerging markets will mitigate risks while still keeping the company levered towards high growth. Already, 85% of business comes from Asia, and stimulus spending in this region has helped lower the downside.

Wynn Resorts (NASDAQ: WYNN) Vs. MGM Resorts (NYSE: MGM)

Compared to LVS, Wynn Resorts is expensive. At around 21x past earnings, even aggressive growth assumptions would not justify the current market assessment. If analyst forecasts prove accurate, 2016 EPS will come out to $9.52. At a multiple of 19x and a 10% discount rate, the intrinsic value of the stock is $112.31 - slightly above the prevailing market price. 4 misses during the last 5 quarters also ruin the momentum story.

But if you take a look at free cash flow, there is reason to be optimistic. FCF has turned around from hundreds of millions in the red to $1.1 billion in five years. With a strong free cash flow yield of around 10%, reward still outweighs risk. Also, I believe that the VIP market will start to improve from an improving macro outlook and greater capacity in hotel rooms.

While LVS and Wynn carry tremendous risk, their fundamentals are still strong. In MGM's case, the risks are high and the fundamentals are weak. From hundreds of millions in losses to intense competition in Las Vegas, the upside is far enough out in the future that to invest now would be to miss out in the attractive returns elsewhere. As analyst Cantor Fitzgerald correctly notes, it was just in early 2009 when the company was possibly a "going concern". While the balance sheet has improved, it is still highly leveraged with poor relative exposure. For these reasons, I recommend avoiding the stock and buying shares in more stable peers.


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