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No Surprises

Can investors rest easy now that second-quarter earnings were what we all expected?

No Surprises

Perhaps the biggest surprise in the recent second-quarter earnings report season is that there were nearly no surprises among publicly traded casino operators.

Earnings came in about as expected with a few better than expected. Business for Las Vegas Strip operators boomed, regional casino companies largely met estimates, Macau suffered from well-known Covid travel restrictions. Just about all companies reported trends continuing into the third quarter and sanguine outlooks were universal, albeit with the sop-to generalizations about slight weakening among lower-rated players.

Even the fallen angels of online gaming operators vowed they have found religion and will become profitable, although we still have to wait until next year for proof of conversion and redemption.

In addition, CFOs and CEOs of land-based operators chanted like a Greek chorus the songs of lower debt, share repurchases and free cash flow. All of that was based on their own conversion to the religion of cost controls and the resultant high EBITDA margins.

And if inflation remains and recession descends? Well, gaming is resilient, the chorus responded.

The sell-side analyst response was largely just as Greek chorus-like. Their hosannas acclaimed the enlightenment of casino operators though some analysts trimmed earnings estimates and target prices, apparently just in case. In fact, there were a couple of instances of raised estimates based on trends and their own analyses, but lowering targets, perhaps to conform to the less bullish outlooks on the economy and consumer spending preached by their firms’ high priests, aka market strategists.

All of this is a little scary, as in when everyone is in the same boat, it often proves to be the wrong boat.

Yet, as light as I am tempted to make of the situation, I find myself in agreement with the optimists. There surely are risks of recession, but just as surely gamers have proven resilient in the past. And with their greater financial discipline, they should remain resilient on the operating side if hard times come. The improved balance sheets are real. The return to stockholders in the forms of share repurchases and dividends are tangible. Free cash flow generation is not only the new mantra, it’s the right metric.

If you’re looking for safety and returns, the gaming REITs—VICI Properties and Gaming & Leisure Properties—are as rock-solid as any equities can be. Their proven tenants provide reliable rents. Their significant and growing dividends and prudent growth strategies are supported by track records of excellent execution.

Use dividends as an example of relative value. The average S&P 500 stock, the classic definition of a blue chip, pays a 1.47 percent dividend. The average real estate investment trust pays a 3.48 percent dividend. VICI yields 4.18 percent and Gaming & Leisure Properties 5.48 percent.

Or use multiples of EBITDA as examples.

Deutsche Bank analyst Carlo Santarelli estimates the stocks of regional casino operators he covers sell at just 7.5 times this year’s enterprise value-to-EBITDA and 7.3 times 2024 projections. Golden Entertainment comes in at just 6.8 times 2024 enterprise value-to-EBITDA with a cash flow yield this year of an outstanding 13.9 percent. Boyd Gaming and Red Rock Resorts are at 11 percent and 11.3 percent. Interestingly, all three are highly exposed to Las Vegas and the Las Vegas locals market.

The big casino operators look like bargains, too, based on his 2024 EBITDA ratio estimates—6.7 times for MGM Resorts, 7.8 times for Caesars and 8.2 times for Wynn. Only Las Vegas Sands, which has forsaken Las Vegas to be a Macau-Singapore operator, is in double digits at 10.2 times 2024 projections.

It also goes without saying that gaming companies have lower valuations than companies in other travel and entertainment industries. Again, using Santarelli’s calculations, stocks of major hotel companies he covers sell at 14 times this year’s EBITDA and 13.3 times 2024.

This undervaluation of gaming companies compared to those in sister industries is not new. It is common for casino companies, especially those in regional markets, to sell at seven and eight times EBITDA while sister-industry stocks sell at 12 and 14 times.

Initially, gaming companies were thought to sell at lower valuations to account for legislative risk. But casinos are long past those early-era risks. They have now been operating for two decades and more with mostly stable legislative environments. So, it would seem, if a hotel stock sells for 14 times EBITDA, why shouldn’t a hotel company with a casino attached sell for at least the same?

Obviously, this is an oversimplification, but it does suggest a safety in the casino business model that should result in higher than single-digit EBITDA multiples. It also explains some of the motivation in selling casino properties to VICI and Gaming and Leisure Properties, unlocking that value and getting big cash payments to reduce debt and freeing up cash flow in return for becoming renters.

Bottom line: From the gentle Greek chorus parody at the start of this column to the examples of relative undervaluations at this end, the conclusion is the same—well-run casino companies should be good bets in these uncertain economic times.

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