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Betwixt and Between

Does stabilization mean that profits are right around the corner? Not so fast...

Betwixt and Between

Twixt and tween.

That pretty much sums up where gaming investors are today as we head into summer.

In looking at industry trends, the words stabilization and recovery are starting to replace the phrases slowing, decline and less bad.

But the progress is unsteady and excruciatingly slow. So slow, in fact, that some observers who believed the optimists that the second half of 2010 would pick up strongly are now putting that prediction off into 2011.

And, increasingly and nervously, some worry that the boom times that peaked three years ago are simply history.

Statistics continue to show a mixture of continuing declines, though less steeply, and scattered and modest progress.

Examples are everywhere. Las Vegas visitation has grown in year-over-year comparisons every month since autumn. But occupancy rates continue to decline and, only in March did average room rates stop falling.

And the gain there was scant.

Meanwhile, forward bookings for groups and conventions remain punk. And no matter how some casino executives stare into rosy crystal balls, the numbers reported in the first quarter tell a more sobering story.

Another case of good news/bad news is gaming revenue along the Las Vegas Strip.

It resumed growth in February and March, but factor out baccarat and revenues declined, though, again, less steeply. Hard-hit markets like Reno and South Lake Tahoe showed gains in March, but the locals markets of the Las Vegas Valley resumed their declines.

Nor have trends in regional U.S. markets been clear. All year, a promising month up has been followed by a disappointment, such as the April dip that followed a nearly break-even March.

If there is one part of the North American gaming industry that appears to have some visibility, it is the suppliers.

In their round of first-quarter conference calls, executives at every supplier company talked about casino customers starting to loosen budgets. And as slot floors age and technology changes games, and as more casinos open throughout the country, a boom in slot and proprietary table game orders is bound to happen.

But when?

One belief is that as casino business recovers, operators will open their wallets. But as mentioned above, that recovery is spotty at best.

Eric McGill of Janney Capital has put some numbers to his forecasts.

He has upped by 1,000 to 17,144 the number of new slot machines he expects to be ordered in North America this year. His 2011-12 projection went up 4,000 units to 16,400.

McGill also sees the North American replacement market growing from 40,000 last year to the mid 40s this year, and then surpassing 50,000 in 2011.

And the replacement market could be dramatically larger, he said. Given that there are around 900,000 slot machines in North America, even replacing them once every 10 years means a more than doubling of sales, McGill may prove right.

And given that when the market breaks, there could be a great release of pent-up demand, sales could be even greater.

Plus there is gaming expansion, and the Canadian VLT replacement cycle. Add all the certain and possible expansions together and it represents nearly 103,000 additional slot machines.

And, what is good for slot machines is good for the makers of table games and bonusing software-in other words, Shuffle Master, Galaxy Gaming and DEQ.

Table games have their own expansion within the general gaming expansion as slot casinos transform into full casinos along with tables, as is happening in West Virginia, Pennsylvania and Delaware.  

And yet, these seemingly inevitable and powerful supplier trends-like those of casino revenue and convention business-still always seem six months away.

Yet inevitability may be the word.

Two sets of statistics on the broader world should lift the spirits of any investor in discretionary consumer stocks.

They are job creation and consumer sentiment. Both have begun to trend up. And as any casino operator knows, gaming revenue eventually is tied to the unemployment rate, though an increase in spending may lag as the newly rehired repair their debts and spend cautiously.

So the positive trends are not firmly established, and we don’t know whether the good times will bring a cautious return or a boom of pent-up demand. Thus, we’re betwixt and between.

But the overall economic statistics and the steadily improving condition of the lending markets give reason to believe there is now light at the end of the tunnel.

The trick for investors, then, is to decide how much of that expected return is already in stock prices.

And there resides another unknown. Will earnings jump so high because of the lower expense bases that recession forced upon so many companies? Or do the high-trailing valuations of many stocks today suggest that the best of the party already is over?

Answering those questions is where analysis meets the crystal ball.

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