In this column a few weeks ago, I talked about using the Foolish 8 screening tool as a starting place to find investment ideas and how a company doesn't necessarily have to meet all eight of the criteria to be an excellent investing opportunity. I also hinted that I had found a company that had piqued my interest and met most of the Foolish 8 criteria. That company -- MTR Gaming Group (Nasdaq: MNTG) -- is what I want to talk about today since it has been one of the more interesting investment ideas to cross my desk in several months.
Who is MTR Gaming Group?
MTR Gaming Group is a gaming (as in gambling) company that operates a handful of casino resort properties that cater to niche markets. MTR is one of the smallest publicly traded companies in the gaming industry, but it is also one of the most attractively priced. In addition, MTR Gaming was recently named #7 on the list of Forbes' "200 Best Small Companies in America," and it made it on that list for good reason.
The company's largest asset is its Mountaineer resort in northwestern West Virginia. Located 35 miles southeast of Pittsburgh, Mountaineer has horse racing, pari-mutuel betting on this racing, casino-style gaming with video lottery machines (not much different than run-of-the-mill slot machines), lodging, restaurants, a spa, and a golf course.
The Moutaineer property broke out of its mold as just a horse racing facility when West Virginia approved video lottery machines at existing racetracks in the mid-90s, largely thanks to the lobbying done by MTR's management. Revenue from these slot machines makes up the majority of Mountaineer's sales and is also used to boost the purses of the horseracing operations.
The company currently has 1,905 slot machines in operation at Mountaineer, but more are in the process of being installed. MTR is also in the process of expanding the amenities throughout the rest of the property, such as adding additional restaurants and hotel rooms, and significant improvement of the resort is ongoing, making the property more of a regional destination resort.
Furthermore, MTR owns two casino resort properties in Nevada -- one in Las Vegas, one in Reno. The company owns and operates the Ramada Inn and Speedway Casino, the nearest casino hotel to the newly opened Las Vegas Motor Speedway in North Las Vegas. Though small by Vegas standards, this property gives MTR future expansion possibilities. MTR also owns the Ramada Inn and Speakeasy Casino in Reno, but this property was recently closed due to a lack of profitability.
Ace in the hole -- competitive positioning
One of the more attractive things in my eyes about MTR Gaming is its competitive positioning in West Virginia. Thanks to statutory limits on gaming in West Virginia, Ohio, and Pennsylvania, there is little to no competition in the markets MTR's main asset serves, and Moutaineer's miniature monopoly in the area is not likely to change any time soon.
The bottom line is that Mountaineer caters to a gambling market where supply is very limited by law, and the barriers to entry are significant and are not going to change for the foreseeable future. This creates a situation where the company should be able to garner excess returns for years to come.
The kicker -- valuation
What really makes the stock interesting in my eyes is its inexpensive price relative to the company's solid positioning and expected growth. The most common metric used in the casino gaming industry is the Enterprise Value-to-EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) ratio, and this ratio is showing MTR as being undervalued.
Typically in the gaming industry, the average Enterprise Value-to-EBITDA ratio is near 8, but as of this writing, MTR Gaming Group's multiple on this metric was in the ballpark of 7. That said, it is almost a guarantee that EBITDA will rise significantly in the coming 12 months thanks to revenue growth at Mountaineer and the closing of the unprofitable Reno property. In the coming 12 months, it is quite easy to see MTR achieving $60 million in EBITDA (or more). In fact, the company has had over $27 million in EBITDA in the first six months of this year alone, with significant year-over-year growth with each passing quarter.
Assuming MTR does achieve $60 million in EBITDA in the coming 12 months, an Enterprise Value at eight times this figure would put MTR's stock at $16, a solid 40% gain from where it is trading today. This may not seem like much of a discount, but considering the company's strong position and the continuing cash flow expected, it is an attractive discount relative to the comparatively low risk the business has of failing.
Even if one doesn't feel like doing all the calculations required to figure out the company's EBITDA and Enterprise Value, one other simple metric shows just how inexpensively MTR Gaming Group is priced -- the forward PE ratio. At this writing, MTR Gaming Group has trailing earnings per share of $0.64, putting the stock at about 18 times trailing earnings. However, the mean analyst estimate calls for MTR Gaming Group to earn $1.30 per share in 2002, which puts the stock at about eight times forward estimates. Any way you slice it, this is an inexpensive valuation.
And what about the stories of the terrorist attacks putting a major damper on the gaming industry? The company's business was slowed in the days after the attacks but has rebounded close to normal and has even shown year-over-year growth in recent weeks. That's the beauty of having a recreational business that caters to the "drive-in" crowd.
The bottom line -- a favorite
When one has the opportunity to pick up a stock at a single-digit forward PE ratio even though long-term earnings growth is expected to be in the high teens, it is worth investigating further. MTR is especially interesting because these inexpensive valuations are typically associated with volatile industries and companies that cycle between profitable years and years with copious red ink. MTR Gaming Group, on the other hand, has a stable group of assets along with an extremely consistent history of profitability and growth.
The combination of a solid business and an inexpensive stock make MTR Gaming Group appear to be a bargain today and one of my favorite ideas in an industry I know well. A company small enough to fall off most people's radars, a business that stands on solid ground, and nearly guaranteed bottom-line growth that has yet to make itself evident on the income statement are all ingredients I like to see in my small-cap companies. I've put my money where my mouth is and have bought shares in the company, strongly believing it's worth rolling the dice on.
Of course, don't go running out to buy the stock just because I said I liked it and owned it! Be a Fool, research it more on your own, and come to your own conclusions. (The September issue of The Motley Fool Select is one place to look for more in-depth info on MTR.)
Paul Larson used to be a casino dealer. Really! Paul also owns a stake in MTR Gaming Group. You can see what else he owns online thanks to The Motley Fool's progressive disclosure policy.
