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Will the Banner Year Be Repeated?

Gaming sector dwarfed the market in 2013

Will the Banner Year Be Repeated?

Stock prices soared in 2013. The Dow Industrials jumped over 26 percent, the S&P 500 over 29 percent and the Nasdaq Composite over 38 percent.

 Chump change compared to gaming stocks.

The Fantini North American Gaming Index soared 74.29 percent, and the Fantini World Index 59.63 percent.

Much of the gain came late in the year, a fact evidenced on the very last day by the number of companies hitting 52-week or all-time closing highs as itemized in the markets section below.

The big jumps came in every sector of the industry:

Las Vegas and Macau megaresort operators—MGM Resorts 102.06 percent, Wynn 80.91 percent, Las Vegas Sands 74.8 percent.

Suppliers—Scientific Games 95.27 percent, Bally Technologies 75.46 percent.

Domestic casino operators—Caesars 211.27 percent, Boyd 69.58 percent, Pinnacle 64.18 percent.

Asia operators—Melco Crown 131.71 percent, NagaCorp 82.7 percent.

Internet companies—Playtech 82.75 percent, Betfair 62.96 percent.

No doubt, those numbers cannot be repeated in 2014. Valuations are stretched. Bullish projections for continued stock appreciation include higher valuations, no stumbles, and no negative surprises. In other words, priced to perfection.

Yet, there appears to be positive fundamental underpinnings to the rise of the stocks—Las Vegas and American economic recoveries, Macau continuing to tap its rich Asian market at double-digit growth rates, convention business and hotel pricing rebounding in the U.S., internet markets regulating throughout the world, including the U.S., the possibility of mega-resort approval in Japan, and perhaps elsewhere.

Having said that, 75 percent gains will not repeat, and the risks have grown.

Here are some thoughts as to why prices are unlikely to rise, and could stumble:

Online optimism is way overdone. Eventually, online gaming in the U.S. might be a big contributor to bottom lines. But not this year. And certainly not to the degree that caused CZR to triple and Boyd to rise 70 percent.

The fact is that online will grow slowly and spottily this first year. And while attention focuses on revenues, there also are considerable costs in the launches, and in player acquisition.

Already, New Jersey airwaves are filled with ads trumpeting online gaming. And TV ads in New York and Philadelphia aren’t cheap.

Slow U.S. casino expansion. The story of the past two years has been cannibalization, as many new casinos do more to take business away from incumbents than to grow their markets.

Expansion slows starting this year. That should provide some relief to regional casino operators, but it also means less top-line growth for companies without new projects, and far fewer new placements for slot machine companies.

Japan. Much like online gaming boosted some American stocks on sheer speculation, others have gotten a rise in the expectations of Japan legalizing casinos.

We’ve raised cautions about Japan before. Let’s repeat here: There is no assurance Japan will legalize casinos. If they are legalized, there is no assurance the rules of the game will favor American casino operators.

As we’ve mentioned, companies that control the multibillion-dollar pachinko industry aren’t just going to roll over for foreign casino operators.

It simply isn’t a given that Las Vegas Sands and Wynn are going to operate Japanese casinos. An investor who makes his calculations based on probability can ascribe some probability to LVS and WYNN, but not a lot.

Negative surprises. Valuations are stretched throughout the gaming industry. It wouldn’t take too many negative surprises to stun investors into ditching the stocks.

A few years ago, it was popular to write about black swans based on a popular book about unpredictable events. That led to lots of columns and research notes trying to identify possible black swans. That in itself was interesting because if black swans cannot be predicted, how can one write a note predicting them?

That contradiction aside, it is true that negative surprises often are unpredictable. But what is predictable is that, when valuations are stretched and investors see only blue skies, stocks are set up to get slammed come negative events.

Stretched valuations.

So, let’s say there are no negative surprises.

Indeed, let’s say things proceed just fine:

• Regional gaming revenues rebound, as they did at the end of 2013.

• Las Vegas booms again, which seems increasingly likely.

• Macau continues to boom and the Chinese government remains accommodative.

• The various Macau and China infrastructure improvements do, indeed, pour millions of new visitors into Macau.

• Japan legalizes casinos with laws that are tailored to the big, public casino operators such as LVS and WYNN.

• Online gaming grows at a rapid—and profitable—clip in the U.S.

Given all of that, how much higher can stocks go?

We are fans of a number of gaming companies, and own stock in them.

But, realistically, prices will not appreciate this year anywhere near the 2013 pace.


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