Safe But Boring

Why casino REITs are changing the financial dynamics of the gaming business

Safe But Boring

Casino stocks may be coming to an interesting intersection of bullish economic fundamentals and rising interest rates.

On the bullish side, the two most important economic measures for casino stocks, jobs and consumer confidence, are hitting their best numbers in decades.

On the cautionary side, the Federal Reserve has been consistently raising interest rates, thus making income investments such as bonds more attractive to investors who have been happily into stocks during this cheap money era.

What makes the intersection interesting is that while the strong economy is filling the pockets of freer-spending consumers today, it also is creating the wage and other inflationary pressures that could prompt the Fed to continue raising rates to the point where they slow the economy and significantly raise the costs of borrowing, or of carrying existing debt.

Interest rates have been held artificially low for so long that businesses have become inured to them, at least to some degree.

Casino companies now talk about debt at 4.5 and five times EBITDA as normal and sustainable. Gaming equipment suppliers, once debt-free, carry long-term debt today.

Casino companies have done a good job of managing debt and guarding against the future—refinancing debt down to lower rates, converting floating interest rate debt to fixed, extending maturity dates.

But the reality is that casinos are capital-intensive. It takes a lot of money to build casino resorts, and it takes a lot of money to maintain and refresh the properties. There will be debt to service.

The time may come when rates rise high enough that the cost of new or refinanced debt crimps growth plans. And if the economy falls into recession, those 4.5- and five-times debt ratios might rise as EBITDA falls, becoming less comfortable.

That, of course, is the nature of the business cycle.

However, there is a new element for gaming companies in this eternal push and pull—real estate investment trusts.

REITs today help casino companies expand by being able to reduce acquisition costs, considering casinos are only buying operations, not real estate and buildings.

The REITs also have been helping to boost casino stock prices as regional properties are being purchased at valuations significantly higher than the historic norm. If properties are being purchased at 10 or 12 times EBITDA, then it follows that the value of regional casino operators is higher than the seven or eight times that have long held sway.

REITs also help the value of companies like Eldorado, Red Rock Resorts and Golden Entertainment that own most, or all, of their real estate by creating a market value for their real estate, which allows investors to imbed some part of that value into stock valuations. That goes for whether investors are calculating takeover value or seeing the potential to monetize the real estate through some other means, such as selling it.

All of which raises a question: What about the REITs themselves?

The three gaming REITs might become more attractive in a slowing economy. Gaming revenues might fall to the detriment of the operators, but they will still pay rent to their landlords, the REITs.

The REITs also are required to pay dividends, and they are significant dividends. Here are their approximate yields today:

  • Gaming & Leisure Properties 7.3 percent
  • MGM Growth Properties 6.0
  • VICI Properties 5.4

Those are good returns in a world of little better than 3 percent yield on U.S. 10-year bonds. And they are going to rise as REITs acquire more properties. Carlo Santarelli of Deutsche Bank calculates that six properties soon to be acquired by Gaming & Leisure Properties will result in a dividend yield approaching 8.2 percent in two years.

Those yields also bring up the value of total return—stock price appreciation plus the dividend. Today, those returns are small. Gaming & Leisure Properties stock, for example, has risen just 3 percent over the past year, providing a total return of over 10 percent.

That isn’t a rocket ride. It falls well below the 25 percent jump in the Nasdaq Composite over the last year, the Dow’s 13 percent jump and the S&P 500’s 17 percent rise.

But it is fairly secure. While other stocks will bear the brunt of the next market downturn, REITs will be cushioned by their reliable revenues and dividends. Not sexy, but safer and, over time, maybe providing an attractive total return.

And if a recession is not around the corner? Well, there are plenty of casinos still to be acquired by REITs, and a big world beyond casinos into which to expand. In other words, there is the potential for growth to raise stock prices over time as well as dividends.

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