Las Vegas has been slowly bouncing back from the financial crisis, benefiting from generally higher overall economic activity. According to the Las Vegas Convention and Visitors Authority, visitors to Sin City totaled 39.7 million in 2012, finally eclipsing the previous high in 2007.
A big recipient of the higher traffic has been MGM Resorts International (MGM -2.58%), owner of nearly half of the resorts on the strip, including Bellagio, MGM Grand, and Mandalay Bay. The company's financial results have been on the upswing and investors have taken notice, bidding the stock price up sharply over the past year. With more states clamoring for gaming outlets and tax revenue, is this the best way to play the sector?
What's the Value?
MGM Resorts is the king of Las Vegas, having spent years building and buying trophy properties, like the Bellagio and MGM Grand. Its pre-crisis, ill-timed bet on Vegas with its massive CityCenter project, however, saddled the company with a large debt load and unsold hotel-condo unit inventory that almost did it in. Fortunately, MGM Resorts' wise move into China almost a decade ago proved to be its saving grace, as strong revenue growth and a rising value of its China unit allowed the company to slowly refinance its debts and wait for occupancy levels to improve in its domestic markets.
In FY2013, MGM Resorts has reported top-line growth, with revenue up 4.8%, led by double-digit gains in its China unit. The company's domestic operations, however, have generated minimal growth due to flat customer traffic and occupancy levels versus the prior-year period. More importantly, the company's current customer base is not incrementally increasing its spending on non-casino products and services, curtailing a source of growth and high-margin income that accounts for roughly 45% of total revenue.
Better Positioned Domestic Plays
While MGM Resorts has been trying to open properties in newer domestic markets like Massachusetts and Maryland, its only major non-Nevada presence is a small portfolio of properties in Michigan, Mississippi, and Illinois. A better sector investment angle would be with the less well-known operators that are benefiting from the growth of gaming across the heartland, no doubt due to the potential tax windfalls.
A case in point is Pinnacle Entertainment (NYSE: PNK), a small operator of casinos in Midwestern markets, including St. Louis and New Orleans. The company has been in acquisition mode lately, highlighted by its recently completed purchase of Ameristar Casinos, which added exposure to new markets like metro Chicago and Kansas City, Mo.
In FY 2013, Pinnacle has reported solid top-line growth, up 6.2%, aided by the late 2012 opening of its latest property in Baton Rouge, La. Its operating margin, however, slipped due to lower per- casino revenue across its older properties as new casinos continue to get approved and constructed in its geographic markets. The combination with Ameristar, though, effectively doubles the company's operating network and should provide cost savings and a lower exposure to the state of Louisiana, the current source of more than half of the company's revenue.
An even more interesting play is Penn National Gaming (PENN -1.92%), a similarly situated gaming company with a large Midwestern presence, as well as a sizable East Coast operation. The company has been an active participant in the growth of gaming across the country, opening two casinos in Ohio and one casino in Kansas in 2012. As a kicker, Penn National is in the midst of spinning off most of its real property assets into a real estate trust, which should provide a stronger capital base and a vehicle for future acquisitions.
In FY 2013, Penn National has likewise reported top-line growth, up 7.7%, as it has gained from a ramp-up in revenue at its Ohio properties as well as a positive bump from the acquisition of Harrah's St. Louis in late 2012. In addition, the company has benefited from an expansion of higher-margin table games in certain markets, including Maine and Maryland. More importantly, Penn National's solid profitability and cash flow are providing the capital to pursue growth opportunities, like its recent agreement to build its first casino in California.
The Bottom Line
Legislatures across the country, from Texas to Kentucky, have found a dependable cash machine in the taxation of casinos and they are trying to get voters to approve new licenses as fast as possible. While MGM Resorts' recent results show that it is out of the infirmary, it is playing catch up in the growth of gaming outside of Las Vegas. Investors would be better off with the smaller operators that are at the forefront of the growth wave with a diversified property portfolio, like Pinnacle and Penn National.
