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Opportunities and Challenges

Two diametrically opposed realities confronted casino operators in third quarter

Opportunities and Challenges

Two themes dominated company comments during the third-quarter earnings report season:

1. Business at casinos is strong and older players, international players and conventions are returning, all boding well for the near-term future.

2. Inflation is starting to have its effects driving up the cost of food and utilities and other expenses, chipping away at the big EBITDA margins that casino companies have so proudly achieved.

Related to those are that games and technology companies continue to enjoy strong support from casino operators, are benefiting from strengthening of their balance sheets and are seeing improvements in supply chains.

However, hovering over these conflicting trends is a Federal Reserve Board of Governors determined to put the brakes on inflation even at the cost of recession.

Casino companies have considerable underlying strengths. They have cut costs. Balance sheets have been strengthened and will be strengthened further. There is plenty of room for revenue growth, whether through existing operations or geographic or physical plant expansions.

But for the foreseeable future, there remains that risk of a Fed-induced recession to worry investors.

And the worry is setting in. Even though stocks ran up fast and far after the latest inflation reports showed modest improvements in trends, both absolute stock prices and valuations are below levels. Whether we are in a bear market punctuated by rallies or whether the worst is behind and it’s upwards from here are arguments for bulls and bears. But the reality is that stock prices as of this writing are still double-digits below their highs.

Regardless of short-term market moves, it is safe to say that if the Fed continues raising rates and scaring off investors and a recession ensues, you can say goodbye to all the sanguine talk about consumers continuing to spend. They won’t. Even without recession, there is mounting evidence that the cash hordes consumers built with Covid relief money are finally nearing depletion and will not be there to finance gambling jaunts.

Sprinkle in higher prices and less discretionary income and the outlook for entertainment companies dims into a world of stagflation. Go past stagflation to full recession and the result for consumer discretionary companies is the same.

And weaker economic conditions will bring lower earnings followed, of course, by lower stock prices likely compounded by tumbling valuations.

If that scenario comes to pass it will spell for long-term investors two enticing words: buying opportunity.

The underlying strengths of today’s casino companies and their still-to-fulfill business opportunities will remain regardless of inflation, recession or bear markets.

And if history repeats, the road back to higher stock prices will begin before the economy recovers, so any investors waiting for the all-clear signal will miss the big upturn.

In short, now and the near future should be good times for long-term gaming investors to be buyers.

Supplying Optimism

Casino companies make the headlines in the financial press. Everyone can visualize the main floor of a casino, a table game pit, the crowds and bright lights of the Las Vegas Strip.

But the real story of gaming in 2022 might be the health and prospects of the supplier companies.

Everyone, it seems, had a positive tale to tell in their third-quarter announcements.

Big players from IGT to little guys like AGS beat expectations. Companies such as Light & Wonder could finally say debt ratios are under control. They and Aristocrat could point to continuing improvement in their business fundamentals. Everi and Inspired Entertainment continued to develop in ways that promise to deliver impressive compounded profitable growth, each with its own special kicker, cashless gaming for Everi and virtual sports for Inspired. All are growing their digital businesses as they develop from casino suppliers into cross-platform games providers.

So, while casinos and sports betting companies grab the attention, investors might do well to look at the engines under the industry’s hood that make it all go.

Now, Macau

Readers of this space are accustomed to my warnings about investing in Macau casino operators. And, for those keeping score, my bearish stance has proven correct, big time.

But conditions change, and now is the time to consider buying the stocks, and especially those of the U.S. listed companies—Las Vegas Sands, Melco Entertainment, MGM Resorts and Wynn.

Macau casinos may never return to the revenue levels of several years ago. In fact, I doubt that they will, given the Chinese Communist Party’s antipathy towards gambling.

But the national Chinese government also is not about to crush Macau’s economy and, for the foreseeable future, that economy depends on the health of its casino industry.

Travel will soon resume to Macau from mainland China and revenues should grow substantially over the next year, taking stock prices with them. That should present a significant trading opportunity. Note, I said trading opportunity, not investment opportunity. Those believing the long-term bullish story for Macau gambling risk being burned by that Communist antipathy.

Of course, this depends on one big caveat—the renewal of gaming concessions. We’ll know the answer to that soon enough, with current betting that they will be renewed.

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