NEW YORK (CNN/Money) -
"You've got to know when to hold 'em. Know when to fold 'em."
Kenny Rogers was singing about poker, not the stock market, in his classic "The Gambler." But you could say the same of casino stocks these days.
Since the market bottomed out in mid-September, shares of casino owners -- or, to be politically correct, gaming companies -- have been among the market's best performers. The Dow Jones Casino Index (yes, there is such a thing) has soared nearly 75 percent since Sept. 21, a stunning turnaround considering the index's 30 percent plunge following Sept. 11.
Now investors face the gambler's dilemma: You never want to leave a hot table too early but you can't stay too long since momentum will shift sooner or later.
Casinos held up relatively well during the recession
Gaming revenue in Las Vegas declined for the first time in more than thirty years last year. But the decline can be directly attributed to the drop off in business in the fourth quarter, according to Daniel Davila, an analyst with Hibernia Southcoast Capital. If not for the terrorist attacks, Davila speculates, gaming revenue would have increased last year.
In fact, casino stocks are a relatively safe haven. For big casino operators like the four that dominate Las Vegas, (MGM Mirage, Harrah's Entertainment, Park Place Entertainment and Mandalay Resort collectively own 18 hotel/casinos in Las Vegas) approximately half of revenues come from casino winnings. The remainder comes from entertainment, room rates and restaurants.
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Hitting the jackpot
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| Casino stocks have been on a winning streak since Sept. 21.
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And the casino is a fairly predictable business that spits out healthy amounts of cash, Davila says.
Sure, every now and then a casino may get hit for a big win at a baccarat table (where some gamblers are known to make bets in the millions). But according to Davila, about 65 percent of gaming revenue for the large casino operators is derived from the slot machines, which are programmed to pay out certain amounts.
"There's an old saying that there is only one way to make money in a casino and that's to own one. You have to work doubly hard to lose money in a casino," Davila says. (Of course, he's referring to the owners and not the people who actually gamble there.)
And now that the economy is on the upswing and travelers have returned to the skies, 2002 earnings estimates for the four major casino operators in Las Vegas have increased by an average of 18 percent over the past three months. Davila says his favorite stock of the top four is Mandalay, which trades at 20 times earnings estimates. Analysts expect Mandalay to post an increase in earnings of 19 percent this year.
Davila also likes Boyd Gaming, a smaller Las Vegas-based casino operator which recently announced that first quarter earnings will be better than expected. Even though the stock has nearly quadrupled in value since Sept. 21, Boyd trades at just 15.7 times 2002 earnings estimates. Earnings are expected to increase by 88 percent this year.
Leaving Las Vegas
Investors do not need to stick to Vegas however. In fact, some of the companies operating riverboat casinos in the Midwest have strong growth opportunities as well. Tom Laming, co-manager of the Buffalo Small Cap Fund, says that he prefers some of the smaller riverboat casino operators to the big Las Vegas-oriented companies because the competition is not as fierce. He adds that demographics are favorable as well, as the aging Baby Boomer generation continues to spend money on leisure activities such as gambling.
It doesn't hurt that these stocks still trade at reasonable valuations as well. Buffalo Small Cap owns Argosy Gaming and Isle of Capri Casinos. Argosy, which owns six riverboats, is trading at just 11 times 2002 earnings estimates. Earnings are expected to increase by 40 percent this year. And Isle of Capri, which owns 15 casinos (a mix of riverboats and land-based casinos), trades at 12 times estimates for its next fiscal year (ending in April 2003). Analysts are predicting a 32 percent gain in earnings.
Finally, one of the best ways to invest in the gaming area may be through International Game Technology (IGT), the dominant supplier of slot machines and other equipment to casinos. The stock trades at 18.5 times earnings estimates for fiscal 2002 (ending in September) and analysts are predicting an earnings gain of 18 percent this year and 17 percent in 2003.
Barbara Walchli, manager of the Aquila Rocky Mountain Equity Fund, says that as more states consider legalizing casino gambling or adding slot machines and video gaming machines to racetracks that could translate to more business for IGT. "There is more pressure on state governments to increase revenues due to budget deficits," says Walchli. IGT is one of Walchli's biggest holdings, accounting for just under 5 percent of the fund's total assets.
Of course in investing, like gambling, there is no such thing as a sure thing. Many of the operators have large debt loads, since they went on an aggressive building binge in the mid-to-late 1990's. Rising interest rates would make it more expensive for companies to add more debt to finance new projects. But that shouldn't be a major concern unless rates spike upward quickly. Favorable demographics and a rebounding economy make casino stocks worth another roll of the dice.
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