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Value in Hard Times

A recession can mean opportunity for investors, and some companies remain good bets even in a bad economy

Value in Hard Times

We’re a good portion of the way through first quarter earnings season as this is being written.

In normal times, earnings reported to date and management outlooks for the balance of the year would make for a sanguine period. There would be the usual concerns over possible—probable?—recession as the Fed keeps raising interest rates, and concern about when that shoe will drop on the economy. But investors can calculate that range of impacts versus business trends and be somewhat confident in their views.

However, this moment in time is not normal. There are two events occurring that may make predictions about the relatively near future based on normally reliable business trends moot.

The first of these is occurring in some cases at warp speed: Big regional bank stocks are dropping fast, some crashing. The second is more of a slow erosion as the commercial real estate market weakens because work-at-home and shop-at-home are severely damaging many office markets and shopping malls.

The banking problem appears to be more of a glitch in our regulatory system. We are not prepared to deal with near-instant depositor withdrawals now possible because of online banking. And, while individual banks or regulators can be justifiably faulted, as in the case of Silicon Valley Bank, which started it all, the contagion of depositor fear and ability to act immediately on that fear has begun to seriously affect otherwise solid institutions.

The solution can be quick in coming if regulators and/or Congress act fast, such as restoring FDIC authority to monitor deposits daily. Commercial real estate problems are longer term, and might be a matter of banks and the industry taking their lumps until the new, lower normal level of business is reached.

In the meantime, businesses generally will suffer, including gaming companies, and especially so if all of these forces result in a severe recession.

For long-term investors, this will present opportunity. Gaming REITs, long among our favorites, should continue to collect their rents with far less concern than those focused on other sectors. Their healthy dividends are a guard against rate-shopping that is another factor in many people pulling money out of traditional banking accounts.

Any sell-off in casino stocks is likely an opportunity, too, though a significant downturn can last a long time. The fact is brick-and-mortar gambling companies sell at low valuations yet operate in a business that should always be in demand. Recessions, hard times, shaken consumer confidence all end. The desire for fun and entertainment doesn’t.

Loose Ends

  • Hail Reeger, or is it Caesar?

    Caesars CEO Tom Reeg, perhaps showing a bit of impatience, if not frustration, over the short-term fixation of gaming analysts, tried to put things in perspective in the company’s first-quarter earnings call.

    Doing some back-of-the-envelope math, Reeg showed how the company reasonably can reach $12.50 a share in fee cash flow in the foreseeable future. That figure is not a stretch, and it compares to a current stock price in the $40s, he noted.

    Assume, again in back-of-the-envelope spirit, 10 times free cash flow—that would mean a $125 stock.

  • Favorite new quote.

    As great an investor as Warren Buffett happens to be, he might be an even better creator of aphorisms.

    Buffett, of course, is famous for buying big, high-quality companies and holding on for years, taking the view he is an owner of a business, not a trader in stocks. Buffett began as an acolyte of legendary investor Benjamin Graham who famously said he was a cigar butt investor, buying stocks selling well below book value to get a last puff from them.

    But over the years, Buffett has changed from a pure value investor to a growth-and-value investor—much, he says, to the credit of his long-time co-investor, Charlie Munger.

    Thus his latest aphorism: Buffett says he has changed from buying fair companies at great prices to buying great companies at fair prices.

    Again, to bring this home, who doesn’t think that Wynn, Caesars and IGT aren’t great companies long-term now selling at fair prices, if not cheaper?

    There are plenty of smaller gaming companies that we’ve mentioned in this space numerous times that fit that bill, but to keep this Buffett-esque, we’ll name just the big ones for now.

  • The lion roars again.

    MGM Resorts seemed to have lost its mojo for many years after the passing of chief shareholder Kirk Kerkorian and CEO Terri Lanni.

    It owned famous names—MGM Grand, CityCenter, Bellagio, Mirage—but didn’t do much with them to excite customers, and as a consequence, investors, beyond maybe spending too much on projects and in operating properties that were blah compared to their reputations.

    Perhaps the best example of MGM during that period was its biggest innovation to lift profits—introducing paid parking in its resorts. It was the bean-counters’ ultimate victory: diminish customer experience because a cost justification matrix said to.

    Since then, leadership has changed. Wall Street firms interested in generating financial returns took control of the board. Bill Hornbuckle, a career gaming guy, was promoted to CEO.

    The results have been impressive. MGM is growing profits, reducing debt and share count, and looking forward to a future of growth nearly baked in for years ahead. Indeed, we might add MGM to that list of great companies selling at a fair price.

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