The Best Stock in Gaming

I'm back again on a search for the best casino stock in the gaming industry. A lot has changed in the industry over the past year with explosive growth on Cotai in Macau, continued deterioration of regional gaming in the U.S., and a new construction boom that will drive the next generation of growth in the industry.

Over the past year, gaming stocks have had an incredible run, as you can see below. My top pick from a year ago, which is Melco Crown (MLCO 0.65%), performed the best over the past year, driven by growth on Cotai.

LVS Total Return Price data by YCharts

Melco Crown has definitely been a great performer financially, but a lot of the gains seen on the market are because of valuation multiple expansion. I'll explain later why that will keep this from being my top stock this time around.

Multiples matter
I'll be using an enterprise value/EBITDA multiple to put a value on these stocks. The enterprise value allows me to pull debt into the equation, and EBITDA is a great approximation of the cash flow casinos spit off from operations. Below, I've built a table with the net debt, market cap, and trailing 12-month EBITDA for each company.

Source: Yahoo! Finance and company earnings releases.

Based strictly on the data above it looks like MGM Resorts is the least expensive and Melco Crown is most expensive. But we have to consider location, growth rates, and future expansion to paint the true picture of the industry.

The U.S., Macau, and Singapore
Melco Crown, Las Vegas Sands (LVS -0.94%), and Wynn Resorts (WYNN -1.79%) all get a majority of their revenue from Macau, an area that's still growing double digits per year. On the flip side, Caesars Entertainment (CZR) gets most of its revenue from regional gaming in the U.S., and the balance in Las Vegas. Regional gaming has struggled with increased competition, and nearly everyone is seeing falling revenue and profits.

Everyone on this list except for Melco Crown has some exposure to Las Vegas, where conditions have slowly and steadily improved since the recession hit bottom. That's where MGM Resorts (MGM -0.46%) gets most of its revenue, with a 51% stake in its Macau subsidiary sprinkled in.

With these positions in mind, Macau exposure should be worth the most with Las Vegas second, and little value placed on U.S. regional gaming, where companies are losing money. That's the framework of the lense I view companies through. Now let's look at expansion.

Expansion in Asia
Every one of these companies has a resort coming on Cotai, except for Caesars. Add to that a stake Melco Crown has in a Philippines resort, and there's a fair amount of expansion coming to the industry. Most of the expansion on Macau won't take place until 2016, but it's still worth looking at when considering upside.

Let's assume that each new Cotai resort generates $1 billion in EBITDA (probably low given existing resorts), and then adjust the valuation multiples. I've accounted for MGM's 51% stake in its Macau subsidiary, and projected a total of $1 billion in new EBITDA for Melco Crown from its 60% ownership in Studio City and minority stake in The Philippines. I haven't adjusted for the majority stake Las Vegas Sands and Wynn have in Macau because I didn't above.

You can see that a single casino added to Melco Crown and Wynn makes a huge impact on valuation because they only have two major casinos, so adding one more changes their respective values a lot. Adding one more to Las Vegas Sands doesn't have the same impact.

The top stock in gaming
When you consider the weakness in U.S. regional gaming, it's easy to write off Caesars Entertainment immediately. Beyond that, Macau is growing faster than Las Vegas, and Cotai is growing faster than the Macau Peninsula. That weights my opinion heavily to Cotai and the current and future operators there.

I'd give an edge to Melco Crown over Las Vegas Sands because it is adding to a smaller casino base, but that's where the debate becomes a toss-up. MGM's results are leveraged by debt, which could help the stock outperform, Melco Crown has expansions with a lot of unknowns, and Wynn's Cotai resort makes it look inexpensive long term.

This quarter, I'll split my picks into two categories based on risk. The low-risk pick based on the values above is Wynn Resorts. The company has a good balance sheet and pays a $1 quarterly dividend along with a regular special dividend, making this a good option for those looking for income. The riskier pick goes to Melco Crown, which has a great balance sheet and will continue to generate strong returns from City of Dreams on Cotai. We don't know how big The Philippines market will be, and if or when Studio City on Cotai will get table games, which adds risk to the stock.

If all of the dominoes fall correctly, Melco Crown could continue its incredible run. But for those looking for a little safer pick, Wynn Resorts is at the top of the list.