The 2 Biggest Lessons About Casino Stocks

Hint: Buy and hold isn't the way to beat the house

   

I’m not kidding with this headline. I think I’ve got “a system” to beat the casinos. It’s so obvious that I’m surprised I didn’t figure it out sooner.

It involves the same reason why trying to place a value on Pixar when it was a public company was impossible. We all knew Pixar made great movies that always generated lots of revenue and cash flow. The problem was that none of the typical financial metrics such as those two or net income, P/E ratios, PEG ratios and so on could ever be predicted, much less calculated for a Pixar.

Casino stocks have a degree of predictability, but less than might seem obvious. Net income growth rates are extremely inconsistent, are heavily dependent on the economy, but are also affected by unpredictable gaming revenues (or losses). Weather can be a factor, and so can business travel and leisure travel trends.

Case in point: Analysts were wringing their hands over Macau’s crappy 1.5% annualized gaming revenue growth in July, following the 50% year-over-year explosion of the past two years. Everyone and their croupier were fawning over Macau’s potential. Then August’s numbers came in — revenue was up 9% — and stocks took off.

So what’s the secret to investing in casino stocks?

First lesson: Casinos are hotels first and foremost. Hotels do poorly when the economy contracts. In those cycles, hotel REITs will be selling property. You don’t want to own hotel REITs or casino stocks at that time. In fact, you may even want to short them.

Second lesson: When the economy is expanding, even a little bit as it is now, there’s no predicting gaming revenue. If you’ve ever booked a room in Vegas, you also have seen room pricing volatility. So, analysts may be able to peg revenue and growth quarter to quarter, but over the very long term, trying to establish a growth rate and therefore a PEG ratio or other valuation metric — well, it can’t be done with any consistency.

Thus, you can really evaluate casino stocks only on a relative basis. Where are they trading relative to highs and lows? To peaks and troughs? To each other within the context of their respective financial positions? In other words — drumroll, please — casino stocks are trading stocks. You don’t buy and hold them.

This naturally leads to what I think about casino stocks’ potential at the moment. What we know is the economy is on the upswing and that China seems a bit shaky, but we have no firm evidence of a hard landing. Hotel average daily rates (ADRs), occupancy rates, and revenue per available room (RevPAR) are all rising strongly. So, the overall directional bias should be upwards.

Wynn Resorts (NASDAQ:WYNN) is, to me, the gold standard for Las Vegas casinos. It generated over a billion dollars in free cash flow in the trailing 12 months (TTM). It was paying down its debt before it drew down more for Macau expansion. The stock is at $105, well off its high of $161, and off the low end of a trading range at $95. Perfect time for entry. Alternatively, buy the stock and sell the October 105 Call for $5.70 for a modest return and less risk.

Las Vegas Sands (NYSE:LVS) sits on a lot more debt, but the company has been paying it down gradually, and TTM free cash flow is $1.6 billion, so it’s also on solid ground. The stock is at $43, off its 52-week high of $62. It, too, is off its trading range low of $37, so I think this is also a good entry point.

MGM Resorts (NYSE:MGM) remains loaded with $13.2 billion in debt, and generating $400 million of free cash flow every year ain’t gonna make much of a dent in that anvil. If you play MGM, it’s because you think that one day in the far off future, it will turn around and you’ll make multiple times your investment.

Caesars Entertainment (NYSE:CZR) is an even worse play than MGM, with $20 billion in debt, $900 million in losses over the TTM, is free cash flow negative and somehow has managed this despite being the most diversified of the lot. Stay away.

Lawrence Meyers does not have a position in any company mentioned.


Article printed from InvestorPlace Media, http://investorplace.com/2012/08/the-2-biggest-lessons-about-casino-stocks/.

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