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Jump or Get Pushed

Weighing the evidence to determine how gaming stocks will fare in 2009

Jump or Get Pushed

It is time to lift our gaze from the wreckage of 2008 and try to ascertain what 2009 will bring.

The big question is the economy. Are we nearing a bottom, in which case stocks might begin their anticipatory rise that precedes better times? Or are we in the early stages of a correcting process that will take years to unwind and will drag the economy into ever-deeper recession?

That is a greed vs. fear choice. On one hand, no one wants to miss the big jump that typically ends a bear market. On the other hand, already-beaten-down investors risk ruin if they catch the proverbial falling knife.

That overarching question aside, there are some positives and negatives to consider in the new year.

POSITIVES
Valuations. Gaming stocks have gone from overvalued to realistically valued, and in some cases undervalued by fundamental measuresùprice to earnings, sales, book and growth rate, debt-to-EBITDA, etc.

This suggests stock prices are nearer a bottom than a top. Obviously, a stock that has lost 80 percent or 90 percent isn’t likely to lose another 80 percent or 90 percent.

However, those measures are relative to fundamentals, and if fundamentals continue to deteriorate, prices can fall.

Missouri, Colorado and budget deficits. Several casino companies are poised to benefit from gaming-friendly referendums that passed in November in Missouri, Colorado and also Maryland.

The biggest beneficiaries: Ameristar, Pinnacle, Isle of Capri.

Meanwhile, states wanting to raise revenues increasingly turn to gaming expansion of various types, which benefits suppliers and lottery companies. This was most clearly evidenced in the Maryland vote.

Capital spending. Casino companies are capital-intensive, and the costs of new casinos have become outrageously high. Now, the postponement, cancellation and downsizing of growth projects are giving balance sheets a chance to recover.

International diversification. Supplier companies especially have benefited from becoming truly international and smoothing out revenue because of it.

NEGATIVES
Debt. Interest expense is going up, a material factor for a capital-intensive industry. Expenses are rising as rates go up, but also as companies refinance debt, or are forced to restructure debt by falling cash flows.

Competition and over-capacity. We’ve seen the effect of Pennsylvania slots on existing East Coast casino operators. More such competition is coming. Meanwhile, in Las Vegas, many thousands of hotel rooms are being added, all targeted to the upscale market that has been flagging all year.

Investor and consumer mood. It may be a long time before investors return to a sector that has burned them so badly. And it may be nearly as long before battered consumers spend freely again.

CONCLUSIONS
Be alert. Look for the potential downside.  A lot of smart people have lost a lot of money believing the stories in a large number of stocks. Who, for example, would have thought Las Vegas Sands would lose 95 percent of its value, or MGM Mirage nearly 90 percent?
Recovery specialists. Look for companies that can pick up the pieces after the storm passes. A nearly universal favorite in this category is Penn National, thanks to its cash hoard, but there may be others.

For example, Boyd Gaming has strengthened its balance sheet by suspending its Echelon project, and Ameristar has its growth projects behind, meaning it will be increasing cash flow and will be able to pay down debt.

Balance sheets. Look for a company secure in its niche and with a healthy balance sheet. Wynn is a favorite of those who like its position among affluent customers. And high quality is always in demand.

Think bonds. Investors tend to focus on stocks. This might be the time to look at bonds and other debt instruments.

The bonds of various gaming companies are yielding double-digit returns. And the prices of the bonds are well below par. Thus, investors get to enjoy big cash returns every year, plus have the opportunity when bond prices recover to sell with the big gains they normally expect from stocks.

Meanwhile, if a company is forced to reorganize or goes bankrupt, stockholders get vastly diluted or wiped out, but bondholders salvage more, and maybe all, of their investment.

And be positive.  Finally, no one knows what the future will bring, whether it will be that sunny day when the bear market ends with soaring stock prices, or that dark spiral down into even grimmer times, or something in between.

But what is known is that stocks historically return 11 percent a year combining appreciation and dividend regardless of recessions, wars or other calamities. And the same is very likely to happen this time. We just don’t know when the turn will come.

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