As companies report second-quarter earnings, gaming investors will, as usual, be focused on expectations for the balance of the year: Are current business trends strong, and do forward bookings and other data suggest strength will continue?
Recent history has been: 1) yes, business trends continue strong, 2) companies continue to maintain big margins as they restrain costs even in the face of inflation and tight labor, and 3) balance sheets continue to improve as debt is being reduced in this era of higher interest rates.
But investors might be wise to ask a broader and longer-range question: Has gaming ceased to be a growth industry?
The fact is few major new markets are left to open. Certainly, there are fill-ins, like satellite casinos in Pennsylvania and new, relatively modest jurisdictions in Nebraska and Virginia, and historical horse racing in odd places such as New Hampshire’s charitable gaming halls. These expansions can be meaningful to small companies pursuing the opportunities, but they are inconsequential in the overall world.
There are international opportunities, but, again, with some exceptions, new markets are relatively small and mega projects like MGM Resorts in Osaka or Wynn in the Middle East are years away and might be basically one-offs.
Every bull’s favorite international market, Macau, is surely coming back, but only in comparison to pre-Covid 2019, not to its peak of a decade ago and certainly not to the levels once dreamed of when investors giddily looked at the low penetration levels of mainland China as an extrapolated pie in the sky.
Even the craze over legalized sports betting and iCasino in the U.S. has faded under the realization that player acquisition costs blunt profit potential, and as new jurisdictional openings slow. Further, governments globally are raising taxes and tightening regulations, which threatens profits.
In the near term, casino operators will tout their uber-margins of 40 percent or so. But cost controls, while welcome, do not grow businesses. You can only shut a buffet one time. You can only charge $7 for a coffee so often before guests get turned off. You can only cut slot payouts and adopt wallet-squeezing table game odds so much before customers realize their money is gone too quickly and the casino isn’t as much fun anymore.
So where does that leave gaming investors? Two answers: 1) finding operators whose growth pipelines still have needle-moving potential, and especially those that reward shareholders with dividends; and, 2) technology and games providers with products that benefit operators financially, whether through higher revenues or lower costs.
Another way to express it is to look for selective growth opportunities.
As noted here before, those are not always the glamor names. They include companies with steady, if not spectacular multibillion-dollar growth plans, such as Boyd Gaming and Churchill Downs.
They include small companies for which even modest projects, such as Full House Resorts’ latest projects in suburban Chicago and Cripple Creek, Colorado, can be transformational.
They include rock-solid cash flow generators that pay dividends, such as Monarch Casino.
And they include companies true to themselves and riding long-term demographic trends like Red Rock Resorts and Golden Entertainment.
We’ve also long been partial to the two gaming REITs, Gaming & Leisure Properties (GLPI) and VICI Properties.They have near bulletproof rent collection and the ability to steadily grow revenues while they return substantial dividends to shareholders.
Interestingly, Carlo Santarelli of Deutsche Bank, a sell-side analyst we admire for both his insight and his courage in being willing to stand out from the crowd, has lowered price targets on both as well as downgrading his ratings from buy to hold.
Santarelli still likes the pair’s underlying fundamentals, but notes their valuations have become high, the merger and acquisition market has cooled under current economic conditions and provides less of a boost to profitability when deals occur, and that higher interest rates have narrowed the gap between their dividend yields and 10-year bond yields.
On the last note alone, Santarelli points out that if GLPI and VICI return to trading at their normal spread between their dividend yields and the 10-year yield, GLPI stock would sell at $35 and VICI at $23. That compares to $48.98 and $31.83, respectively, on the day before Santarelli released his report.
No sooner had the ink dried on Santarelli’s report than the stocks sold off along with the overall market and, perhaps in part, to his report.
As of this writing, GLPI is trading at $47.35 and VICI at $30.94, giving both about a 10 percent appreciation to Santarelli’s targets of $52 and $34, plus investors get a 6 percent dividend yield on GLPI and 5 percent on VICI.
To boot, they are using their investment-grade credit ratings to finance tenant expansions that, over time, will lead to higher rental incomes.
So, both still offer profits to investors, and I, for one, continue to buy the REITs on dips. However, Santarelli’s point is a good one in an industry where growth has slowed and where VICI, for example, already has acquired the lion’s share of property available on the Las Vegas Strip.
The larger point is that it might be time for investors to reappraise the entire gaming investment space. The upcoming earnings season and accompanying investor conference calls will be good starting points in that process.
