Ready to Try Your Hand With These Gaming Stocks?

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

Lady Luck and Mr. Market sure haven't been kind to investors in gaming stocks over the last five years. Once the darling of Wall Street, the industry was rejected like lukewarm food from a buffet steam table.

Similarly, like many casino buffet patrons, casino operators gorged on easy money to saturate not only Las Vegas and Atlantic City, but also major metropolitan areas. Who would've thought that we'd find casinos in Philadelphia, New York City, and Cleveland?

So-called "convenience" gaming is supplanting "destination" gaming, to the detriment of traditional operators. Those with major Las Vegas exposure, such as MGM Mirage (NYSE: MGM), are saddled with debt and money-losing operations. Dividends from them are out of the picture for now.

Yet at the same time, smaller companies in the industry have experienced stock price run-ups over the last month.

Penn National Gaming (NASDAQ: PENN) made waves last month when it announced plans to split into an operating company and a casino REIT named PropCo that would collect rent from the former, paying a one-time $15.40 taxable dividend - $5.35 in cash and $10.05 in REIT shares. Moving forward, the REIT will pay a generous $2.36/share dividend.

Investors have since bid up Penn's rivals, hoping that more REIT conversions are imminent and desperately seeking dividends. But UBS REIT analyst Russ Nussbaum is bearish, warning that PropCo's dependence on one tenant warrants a discounted valuation. Barron's authors Vito J. Racanelli and Kopin Tan share Nussbaum's view, with Racanelli kidding that "the U.S. Post Office, which owns mailboxes around the country, and Greece, with its beautiful islands, are both considering turning into REITs in order to save big-time on taxes" as well and Tan stating that investors' shift to REITs "will not end well."

That being said, the depressed valuations of gaming stocks may present opportunity if the companies are analyzed for what they are and not what they may become. Who are the high rollers -- whales, in industry parlance -- of secondary market gaming then, and how do they stack up?

Pinnacle Entertainment (NYSE: PNK) operates luxury casino resorts in Lake Charles, La., Baton Rouge, La., and St. Louis, Mo. Its flagship properties are the five-year old Lumiere Place in St. Louis and the seven-year old L'Auberge du Lac in Lake Charles, which serves Houston, a thriving city two hours away with no casino of its own.

Pinnacle was punished over the last few years for its costly missteps in Atlantic City, N.J., where it purchased and demolished the struggling Sands casino but, beset by a turn in the city's fortunes, ultimately opted not to rebuild. The site remains empty and is estimated to have shed 90% of its value.

Isle of Capri Casinos (NASDAQ: ISLE) is Pinnacle's only competition in Lake Charles, offering a more affordably priced option with its Isle of Capri Casino. In other news, it recently exited the crowded Biloxi, Miss. market and opened a new casino in Cape Girardeau, Mo. Initial signs are positive for this $135 million property, which took in $5.4 million in revenue in November, its first month, especially in contrast to the tepid results achieved by new properties in other states such as N.J.

Isle of Capri trades just over book value and at eight times forward earnings. It lost money in the trailing 12 months. 

Ameristar Casinos (NASDAQ: ASCA) competes with Pinnacle and Penn National in the St. Louis market. It is the only stock of this group that pays a dividend, a pretty meaty 2.5%. It trades at a trailing P/E of 8.65 and a forward P/E of 9.51, a discount to the others. It doesn't seem very exciting after its recent run-up, but if it pulls back towards its 50-day or 200-day moving averages, it could be a steal.

The bottom line

Like it or not (I don't), gambling has entrenched itself in our culture enough that we've allowed the gaming industry's tentacles to creep into our backyards. It seems like the industry is here to stay and has largely matured.

Their long-term growth prospects domestically are nil, but in the near term, these companies could unlock shareholder value by splitting into operating companies and REITs.

How much more value there is to unlock remains to be determined, though. These highly leveraged companies have been on a tear this year, posting stock-price gains that range from 10% for Isle of Capri to 26% for Penn National.

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ASCA data by YCharts

Results were even better for those who bought during the summer, when all three dipped and Pinnacle and Ameristar reached 52-week lows. Keep this in mind if you do want to buy in, and enter on dips. The underlying businesses aren't going anywhere soon.

Fool blogger Jonathan Lim 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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