Are Casino Stocks Actually Cheap?

There's one thing about which there's no debate: Stocks in the gaming group have been a bad bet for those who bought in pre-crisis. MGM Mirage (NYSE: MGM  ) and Las Vegas Sands (NYSE: LVS  ) are down more than 90% from their 2007 highs, while Wynn Resorts (Nasdaq: WYNN  ) is down a "more modest" 75%.

On a parallel track, there's lots of debate among investors trying to figure out whether financial leviathans like Citigroup (NYSE: C  ) , Goldman Sachs (NYSE: GS  ) , and Morgan Stanley (NYSE: MS  ) are sporting bargain prices. Their price tags may look low in comparison to 2007, but some worry that they may have been overvalued and benefitting from unsustainable earnings. I believe that's exactly the question we need to tackle for the gaming companies.

With that in mind, let's take a look at the valuations of four gaming stocks -- MGM, Las Vegas Sands, Wynn, and smaller competitor Ameristar Casinos (Nasdaq: ASCA  ) -- to get a better idea of whether we're looking at a royal flush or a toilet flush in the casino industry.

So are they cheap?
To figure this out I set up a spreadsheet delving into the past eight years of results from all four companies. Using a little Excel magic, I then estimated the earning power of each company and based my "cheapness scale" on how that earning power compares to today's price. I could give you the gory details, but I want you to keep reading, not fall asleep.

MGM
Cheapness scale: dirt cheap

MGM is clearly the cheapest of the group. While significant concerns over the potential for the company to go bankrupt have largely gone away, they still linger to some extent. The upshot to those concerns, though, is that they have left the stock comically cheap for those confident in the company's future.

To ascertain that MGM is dirt cheap, you don't have to mess around with the complicated modeling that I did. The stock is currently trading at a relatively low multiple on its depressed earnings over the past year (adjusted for goodwill impairments and other one-time impacts) and well under its tangible book value.

We'll get a better look at how the recent debt and equity offerings shift the numbers around when MGM reports earnings early next month, but I suspect that it will still look crazy cheap.

Ameristar
Cheapness scale: this ain't full price

By a nose, Ameristar gets my nod as the second-cheapest among the gaming group. By focusing on smaller regional markets, Ameristar has been able to produce a return on its assets well above what MGM has -- though obviously with a lot less scale. Its scary-looking balance sheet had investors running for the hills late last year, but the stock has quadrupled since then. Even with that massive run-up, this still looks like a reasonably valued company.

Las Vegas Sands and Wynn
Cheapness scale: this ain't full price

Las Vegas Sands and Wynn are more difficult to deal with, because of more limited operating histories and a significant number of new property openings in the past few years. I suspect that going forward, both will probably see higher returns on their assets than MGM, but not quite as good as Ameristar. It's also worth noting that both Las Vegas Sands and Wynn are still in growth mode, with Marina Bay Sands and Encore at Wynn Macau both expected to open in 2010.

Though I see Sands and Wynn as considerably more expensive than MGM and slightly pricier than Ameristar, taking into account the quality and expected growth for both, I've put them in the same cheapness category as Ameristar.

So what's the catch?
These aren't cheap without reason. As I noted above, the balance sheets are pretty ugly almost across the board -- with Wynn potentially qualifying as "less ugly" -- and many investors expect that operating conditions will be tougher for the casinos going forward.

To that I would add my concern that management at these companies won't know when to go from growth mode to "cashing in" mode. Between 2000 and 2008, every one of these companies has consumed rather than produced cash, with both MGM and Las Vegas Sands spending more than $9 billion. There's certainly value to growth, but I'm a fan of companies that are putting cash in the bank, rather than tapping the bank for loans.

Laying down bets
The lack of clarity about the future of the gaming industry combined with unwieldy balance sheets puts the casinos out of the picture for most conservative investors.

For a risk-taker looking for deep value and the potential for big returns, MGM could trounce the market over the next few years if it continues to outrun the bankruptcy bogeyman. Wynn and Las Vegas Sands could be of interest to growth-oriented investors as both add properties and see their returns come back to a more normal level.

Ameristar doesn't have the rock-bottom valuation that MGM does, and growth is unlikely to be on the menu until it gets its balance sheet under control. This, combined with the risk still inherent in its operations, makes it my least favorite of the group. It is, however, the only one of the four that pays a dividend.

So what do you think?
To back up my thoughts, I've rated both MGM and Las Vegas Sands outperformers in my CAPS portfolio (I gave Wynn the nod back in April). Now it's your turn to let the CAPS community know what you think. Are the casinos great buys? Or are they sinkholes with stocks on the verge of plunging? Click here to join the 135,000-member-strong community.

Further Foolishness:

Ameristar Casinos is a Motley Fool Hidden Gems pick. Want to crib from the experts' notes on why? Click here to start your free 30-day trial to the service. There's no obligation to subscribe. 

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned in this article. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy likes to riffle in the rain.


Read/Post Comments (3) | Recommend This Article (20)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 22, 2009, at 5:48 PM, spokanimal wrote:

    Re: "MGM could trounce the market over the next few years if it continues to outrun the bankruptcy bogeyman"

    How?

    This company is all Las Vegas and Vegas is mortibund. Even as some growth returns to Vegas, there's a mountain of new hotel rooms coming on line over the next year.

    There's also a question of where the growth will come from. Most of the states in this country are falling all over each other to legalize gaming. Vegas may be world class but it's a mature market now and you can gamble close to home about anywhere you live.

    Las Vegas Sands is a different story. By this time next year, almost 85% of their revenues will come from Macau and Singapore. These are fast-growing, captive markets just as Vegas was 25 years ago. To the extent one worries about competitive pressures among the 6 licencees in Macau, one should remember that Singapore has only 2 big venues.

    As I stack up the growth prospects of the major gaming companies, LVS is #1, Genting #2, probably Melco #3 and Wynn probably down around #6. MGM is second to the last... clearly behind Harrahs, which isn't good... but ahead of Trump, which is dead meat.

  • Report this Comment On July 22, 2009, at 8:17 PM, TMFKopp wrote:

    @spokanimal

    The article above focused primarily on valuation. As such, the opportunity I was referring to with MGM's stock is the fact that it carries such a low valuation. However, there are also some new directions that MGM is taking its business that could provide growth and exposure to foreign markets without the need for massive capital spending (http://www.fool.com/investing/general/2009/06/17/mgms-new-re....

    When it comes to Vegas, I think people have been proclaiming the end of Vegas for a long time. Maybe this time it's different, but I wouldn't count on it. There are great opportunities outside of of the U.S., but I wouldn't just shrug off the base of business that's still available in the U.S.

    As for your thoughts on Las Vegas Sands, I don't disagree on the growth prospects or really the overall attractiveness of it as a (risky) investment. However, you can't consider growth prospects in a vacuum. Along with that growth, Sands also has one of the uglier balance sheets of the sector and is valued at a premium to many of the other gaming stocks.

    As I noted above, I'm concerned that gaming management teams aren't going to know when to shut off the capital spending spigot and start collecting cash. I think Sands seems to be most at risk of not knowing where that line is.

    But as I outlined above, I'm positive on Sands along with Wynn and MGM.

    Matt

  • Report this Comment On July 23, 2009, at 12:52 PM, multi007 wrote:

    I bought MGM based on these same observations about 6 months ago. I still continue to hold.

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