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Can't Get No Respect

The casino industry often has superior results, yet gets little consideration

Can’t Get No Respect

In the world of leisure and hospitality, investors give casinos little respect.

And in the world of casinos, the small regional operators get the least respect of all.

At least that’s the case if using the enterprise value/EBITDA ratio, which measures the value of a company vs. the cash it generates that can be spent today.

Below are some EV/EBITDA average ratios based on a recent sampling:

• Hotel REITS                           15.3 to 1
• Fast casual restaurants         15.2
• Big lodging operators           13.4
• Fast food restaurants            10.7
• Big casino operators             10.4
• Cruise Lines                           9.5
• Amusement, theme parks      8.5
• Full-service restaurants         7.8
• Big regional casinos               7.9
• Medium-size regionals          7.0
• Micro cap casinos                  3.7

This gap in perceived value of casinos and related industries has been around for years.

On the surface, it doesn’t make sense. A hotel is a hotel. But a casino resort is a hotel with a money-making casino attached.

Further, casino licenses are limited everywhere in the United States except Nevada. Mississippi, New Jersey and Colorado have no caps, but only certain locations can have casinos.

Elsewhere, if you don’t have a license, you have to buy a company that does or you’re out of luck.

However, you can put a hotel anywhere, including across the street from an existing one. There is no moat separating you from competition.

Thus, with constrained supply and the kicker of a casino to go with a hotel, one should think casinos would be more valuable.

But that isn’t the case. A main reason is legislative risk. As we’ve seen time after time, legislatures can beat up on casinos with punitive taxes and stultifying regulations.

Still, casinos are recurring revenue machines that, despite the dips in the last recession, are fairly resilient businesses.

Of course, another factor that goes into valuing a company is its growth prospects, and here is where casino companies shake out within the industry.

Take the big casino operators. Of the four we list, three have Macau operations and all four are in Las Vegas, the former still seen as a growth market and the latter as on the rebound:

Operator                 Trailing EV/EBITDA Ratio

Las Vegas Sands      12.1
Caesars                   10.5
Wynn                        9.9
MGM Resorts            9.1

It is when you get into regional markets that the fear of cannibalization begins to scare investors away. Consider the lower EV/EBITDA ratios of what we’ll call the big regional operators, both of which also have Las Vegas operations:

Boyd                         8.7
Penn National           7.1

Note, Las Vegas makes up a much bigger part of Boyd’s business between its locals and Down-town casinos, compared to Penn’s one property 10 miles south of the Strip.

What we’ll call the mid-size regionals come next:

Pinnacle                   7.4
Ameristar                 7.0
Isle of Capri             6.7

The smallest gaming operators are all over the place, as they should be, given how different they are from each other:

Nevada Gold & Casinos  6.9
MTR Gaming                  7.2
Monarch Casino             7.5
Century                          4.4
Lakes                           -7.6

So what do we make of the lower valuations, other than a reading of investor sentiment?

One is that companies with strong balance sheets and proven management might be relative bargains, perhaps Wynn among their peers.

Among the regionals, PENN is interesting, given it generates significant cash flow and has new properties opening that should more than offset what it loses to new competitors.

Barclays analyst Felicia Hendrix recently noted that in a worst-case scenario, expanded Maryland gaming would cost Penn’s Charles Town, West Virginia, casino $82 million in EBITDA, or $3 to the stock price, yet the shares had fallen $7 since early July.

And Mark Strawn of Morgan Stanley forecast $500 million in free cash flow next year, a 13 percent yield.

Finally, MTR Gaming could be Penn National in miniature. While attention is focused on revenues it is losing at Presque isle Downs in Pennsylvania to the new Horseshoe Cleveland in Ohio, MNTG has its own new Buckeye State gaming operation with slots at Scioto Downs near Columbus.

And CEO Jeff Dahl recently reached into his pocket to buy 7,600 shares at $3.80 to $3.85.

Dividends

At present, paying dividends is an attractive way to return capital to shareholders.

We don’t know if that will remain the case, as Congress has got to decide how to raise revenues to reduce deficits.

But if dividends do remain attractive, gaming companies might be worth a look as income and growth stocks, with the likes of Ameristar and IGT paying dividends.

And many international gaming companies routinely pay dividends.

The two most assertive U.S.-listed dividend payers are expected to be Las Vegas Sands and Wynn as their Macau and other operations are churning out more money than they can reinvest in growth.

Indeed, Steve Kent of Goldman Sachs not long ago issued a report showing how both companies are generating so much cash they can be debt-free in the relatively near future even with their current growth projects.

Right now, LVS pays a dividend of $1 a share that yields 2.2 percent. However, there is speculation of an increase, and a special dividend is possible.

Wynn pays $2, which equates to a 1.8 percent yield, but the company likes big special dividends, and speculation is that it will pay somewhere between $5 and $10 in December.

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