How do you account for the dramatic, rapid rise of casino company stocks since March, even as attendance and revenue at many venues are down versus comparable periods last year, and even though balance-sheet remediation is still a work in progress?
Could it be optimism about a sharp economic recovery in the U.S. that would include a dramatic snap-back of discretionary spending and consumer confidence?
Might it relate to a hoped-for best-case scenario in Macau, anticipating an exploding market once the Chinese government makes infrastructure improvements and eases restrictions on travel?
Perhaps it's following the lead of traders, who bet that the risk of bankruptcy during the deepest debt despair for Las Vegas Sands (NYSE:LVS) and MGM Mirage (NYSE:MGM) was outweighed by the buying opportunity when both fell below $2 early in the year?
Or is it just irrational exuberance?
Go figure
For the average investor, the foundation for such extreme optimism is hard to measure in an industry where a junk bond rating is the rule rather than the exception.
A standard metric like the price-to-earnings ratio offers little help. Of the nine largest publicly traded casino operators, eight have no trailing-12-month P/E because they had no "E" during that period. Isle of Capri Casinos (NASDAQ:ISLE), with the smallest market cap of this group, is the exception.
Seeking wisdom from sell-side analysts probably won't embolden average investors, either. Major players with spectacular short-term stock gains -- MGM Mirage and Wynn Resorts (NASDAQ:WYNN) -- are among the least liked by Wall Street. Both have a bell-shaped curve for ratings -- a handful of buys and sells plus a majority of holds, according to Thomson Reuters data.
Still, since early March, Wynn is up nearly fivefold and MGM Mirage is up about sevenfold.
Wall Street's reluctance to forecast a comeback extends to some smaller operators, most notably Boyd Gaming, whose stock has tripled since early March. For those keeping score, analysts give Boyd one buy, 10 holds, and four sells.
Contrarian views
Equity analysts aren't squeamish about all casino companies. Their buys equal or exceed their holds-plus-sells for Penn National Gaming (NASDAQ:PENN), Ameristar Casinos (NASDAQ:ASCA), and Pinnacle Entertainment.
As luck would have it, shares for these neither Vegas nor Macau companies have trailed MGM Mirage and Wynn Resorts over the past six months.
This group also lags the returns from Las Vegas Sands, which picked up more Wall Street supporters in recent weeks as the stock now trades 14 times higher than in early March. Analysts now have eight buys, seven holds, and two sells.
External trends
Once you get past the dramatic stock increases, investors who didn't get on the bandwagon -- and even those who did -- should check the nitty-gritty of balance sheets as well as trends for discretionary spending and tourism.
Casino company revenue remains chronically depressed in Las Vegas and Atlantic City thanks to fewer visitors, discounted hotel rooms, reduced consumer spending and, for Atlantic City, increased competition from neighboring states.
Recent results from Macau during 2009's first half were discouraging, although July and August outpaced the year-ago period. Macau was aided by the June opening of a luxury casino resort from Melco Crown Entertainment (NASDAQ:MPEL).
Internal financing
Since late last year, the largest casino operators and some smaller ones have tried to shore up their finances by issuing more stock and/or issuing new debt. Wynn Resorts and Las Vegas Sands are moving toward initial public offerings of their Macau properties.
New debt lets companies pay off existing debt and remain in compliance with lenders' covenants, but rating agencies remain wary. Here are a few recent examples from Fitch Ratings:
- The firm has below-investment rating grades for Wynn Resorts and its Las Vegas and Macau subsidiaries. Fitch says the Las Vegas credit profile is "considerably weaker" than Macau. Without "additional support," it is "highly unlikely" the Las Vegas business can meet loan covenant requirements in 2011. Thanks mostly to Macau, Wynn has a stable outlook.
- Although Fitch gave MGM Mirage a slight upgrade when the casino operator announced plans in May for a $2.5 billion capital raising, the rating remains firmly at the junk bond level.
- Although ratings for Pinnacle Entertainment remain below investment grade, Fitch raised the outlook to stable from negative in July thanks to an amended agreement with lenders and a new debt issuance announcement.
The next round
Back on July 22, my fellow Fool Matt Koppenheffer concluded that some casino stocks were cheap. At that time, Wynn closed at $42.26, MGM Mirage closed at $7, and Las Vegas Sands closed at $10.25. That was then, this is now.
With many debt issues being more delayed or deferred than solved, and with the degree of economic recovery uncertain -- including prospects for discretionary spending -- investors might heed the strategy of professional gamblers: Walk away with your winnings.
