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Bad News, Good News

Declining gaming earnings and subsequent stock declines were expected, but the result is good bargains

Bad News, Good News

First-quarter earnings have now been reported by casino operators, leaving us with one statement: Finally.

And one question: But when?

The finally part is that earnings finally weakened after it was clear for months that business conditions had declined, especially for regional operators.

The blame has been placed on a variety of things, including harsh winter weather, and there is some truth to that. But the reality is that business had been slowing down, a fact somewhat masked in Las Vegas by an events calendar that included mega happenings like Formula 1 and the Super Bowl.

Another factor depressing earnings is the cost of labor. Its rise in Las Vegas had been well publicized as Culinary Union contracts were negotiated, but labor costs also rose in regional markets.

And, while casino executives have talked about business volumes normalizing since the first quarter, the latest gaming revenue reports from various states show the declines continuing, and accelerating in some cases.

Readers of this space would not be surprised by the weakness in business, as we’ve repeatedly warned about it and it was just a matter of time before it showed up on P&Ls.

So much for the bearish part of this column.

The bullish part is in the question: But when?

The reality is that casino stocks have been falling behind the overall market for some time, and it is just a question of when investors will notice bargains, including among the best companies in the industry, like Wynn Resorts.

The decline in stock prices might not be over. There’s no telling what impact a recession would have, and gaming stocks certainly can fall further if the overall market sinks after its big runup over the past year.

However, at some point value will be recognized. And that might be happening now. A number of casino stocks held their own or even modestly advanced after first-quarter earnings dips, which may suggest the worst is in, at least relative to the overall market.

In fact, with the caveat in mind that the overall market could tank and take gamers along with it, I think we can say casino stocks have hit bottom and it should be up from here.

Here are some of the first-quarter winners:

The big boys: Wynn and MGM Resorts.

While others were making their excuses, these two companies beat expectations. In part, that was thanks to the resurgence of Macau, where both gained market share. To a great extent, it is thanks to the uniqueness of the Las Vegas Strip, a one-of-a-kind market in the world.

Both companies should benefit by their growth prospects and by having affluent customer bases at a time when lower-end customers are cutting back. And at valuations below eight times EBITDAR for MGM and below 10 times for WYNN on even bullish analyst price targets, the stocks should prove very rewarding.

The home boys: Red Rock Resorts and Churchill Downs once again demonstrated that profitability and growth can come from drawing players close to home. Such results also come from excellent execution of strategically sound growth plans. For Red Rock, that’s operating best-in-class Las Vegas locals properties. For Churchill it is capitalizing on (and in fact, leading) the proliferation of historical horse racing machines, as well as fully exploiting its unique Kentucky Derby franchise.

Neither stock is cheap compared to peers at over 10 times analyst EBITDA forecasts and target prices, but those valuations are cheap compared to their growth rates, and compared to longer-term growth prospects not yet in analyst forecasts.

The value plays: Golden Entertainment and Penn Entertainment.

The stocks of both of these companies are way below their highs, and both gave plenty of reasons to disappoint investors based on their first-quarter performances and, in PENN’s case, its own financial guidance for the coming year.

To a great extent, both companies have done it to themselves. Golden said to heck with diversification and sold off its route businesses and Maryland casino to become a pure southern Nevada casino and bar operator. PENN, after a losing sports betting experience with Barstool, jumped back into the fire by making an expensive commitment to its new ESPN BET operation.

What’s lost among investors is an appreciation for the soundness of their basic casino businesses, especially given valuations of under five times EBITDA for PENN and around 5.5 times for GDEN.

PENN will eventually either make ESPN BET work and the stock will soar, or it will go on and be valued for its sound regional casinos. Either way, the stock should be well above today’s level, though that is expecting an investor to have both patience and confidence in management.

Golden is a now cash-flush, solid operator in a growing market that should be selling at least a third higher just to match peers. And its peers are undervalued.

That gets us back to one of the themes of this column. Many casino stocks are too cheap, and the time may be at hand when investors act upon that fact.

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