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Numbers Don't Lie

The recession may be over, but how will it impact the U.S. regional operators?

Numbers Don’t Lie

The recession might have officially ended last year, but that brought no consolation to casino companies, as the industry’s recession continued into 2010.

But there are signs that the long-awaited recovery is under way. After months in which gaming revenues stayed at their lowest levels, and even slipped some more, they are starting to revive.

Nearly every state reported September revenues that, on a year-over-year comparison, were much stronger than August, and much stronger on a year-to-date basis. The good news was especially true from Pennsylvania—which continues to ramp up slot win and now has table games giving it a further boost—to New York to West Virginia, which reported solid improvements over last year.

As has been said many times, consumer discretionary companies, such as casinos, rely on jobs and consumer confidence for people to resume spending on non-necessities.

And figures in the broader economy are starting to trend positive, such as the declining number of first-time unemployment claims, and the modest rise in home sales.

So who in the gaming world would most benefit from a turnaround? Our guess is that the first beneficiaries would be regional and local casino operators.

Recovery will take a while. No one will flip a switch for consumers to spend with abandon. That will be especially true coming out of this recession, given the damage to confidence and the still-punk housing sector.

Consumer spending will return slowly and tentatively.

In that regard, it makes sense that gamblers will venture out to their local riverboat or racino rather than fly off to Las Vegas. And they will more likely walk over to the buffet than blow $400 a couple at a four-star restaurant.

As with so many companies, the regional casino operators have reduced their expenses to the point that even modest revenue increases can boost their bottom lines.

Thus, the businesses may be in place to prosper, at least relatively.

Some expectation of improvement has been built into the stock prices. Ameristar is around 35 percent above its 52-week low. Penn National is up more than 40 percent, Pinnacle more than 60 percent.

And, yet, the stocks could have a way to run. Ameristar is about half of its pre-recession high, Pinnacle a third, Isle of Capri a fourth, as examples.

Of course, many observers do not expect business conditions to return to those boom times for years. And even optimists wince, rather than celebrate, when companies talk about expansion. Investors are more afraid of added debt than bullish about growth. How cheap casino stocks have become, and how dismally investors see their prospects for earnings growth, is told by their price-to-sales ratios.

That measure is about or below 1.0 for all of the five largest regional operators. Here are the numbers as of this writing:

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They also are relatively inexpensive, though not screamingly cheap, but another ratio is enterprise value to EBITDA. Consider:

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    And not at all cheap by this measure:

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Of course, each company has its opportunities and challenges. Ameristar, for example, thinks that combining its dividend with the projected value of its debt reduction creates the equivalent of a 10 percent to 12 percent annual return. Ameristar also has the chance to be bought out at a premium.

And Ameristar, Boyd and Isle of Capri have similar cost-cutting stories.

Pinnacle, likewise, has cut costs, and CEO Anthony Sanfilippo is making a point of improving operating margins, an achievement that could be worth several dollars or more per share.

Pinnacle also has growth prospects, such as continuing to ramp up its new River City casino in suburban St. Louis, and in building its $357 million property in Baton Rouge.

Penn National is the regional operator with plenty of growth opportunities: table games recently added in West Virginia and Pennsylvania; the new Maryland slot casino; casinos coming in Columbus and Toledo, Ohio, and Kansas City, Kansas; and the possibility of slots at its Toledo and Columbus racetracks. And now, Penn has added M Resort, and executives believe they can generate a double-digit return on their $230 million investment.

One knock on regional casinos is that the market has matured, meaning new properties take away more business than they generate. Certainly, that phenomenon has been evident everywhere from Atlantic City to Indiana.

Penn, on the other hand, is the new competition in most of its markets, though its huge Hollywood Casino in southeastern Indiana will face new competition when Rock Ventures and Harrah’s open their Cincinnati casino.

Still, the biggest overall impact comes from the economy, and as the recession truly ends, regional casino companies may be worth a look.

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