Q: Is the gambling industry cyclical?

A: Of course it is -- but it's not at all what it used to be.

I was reading through an article on Isle of Capri (NASDAQ:ISLE) a couple of weeks ago, where my colleague Ryan Fuhrmann mentioned that the "gambling industry is highly cyclical." I thought that was interesting, because with the almost non-stop industry-wide boom over the past several years, cyclicality is a topic that we haven't really talked about much.

That said, I have to disagree with Ryan's assertion to an extent, as I believe that the industry has fundamentally changed in the past two decades, thanks to both widespread expansion into new jurisdictions and an all-time high in gaming demand.

Gaming expansion and the shift
In general, the hotel business is regarded to be more cyclical in nature than the gaming business. And clearly, the most cyclical component of the U.S. gaming industry is the destination hotel business on the Las Vegas Strip. However, since South Dakota became the third state in the U.S. to legalize gambling in 1988, full-scale commercial gaming has spread to Iowa, Illinois, Missouri, Indiana, Louisiana, Michigan, and Colorado. In the process, the gaming industry has shifted from being dominated by the destination hotel/casino business on the Strip and the hybrid destination/locals Atlantic City market, to include what is now a more widespread locals business, where the average patron lives within 100 miles and visits a couple of times per month.

Indeed, gaming revenues in the eight new jurisdiction states mentioned above totaled $13 billion in 2005, or greater than the $11.6 billion in gaming revenues in all of Nevada. In addition, the Chicagoland, St. Louis, Detroit, Southern Indiana, and Kansas City markets -- all of which function primarily as locals markets, and none of which existed 20 years ago -- combined for $6.34 billion in gaming business in 2005 -- better than the $6.03 billion on the Las Vegas Strip.

And none of the above figures include the substantial racino business either existing or on the way in states such as West Virginia, Pennsylvania, Florida, New York, Maine, and Delaware. I figure Pennsylvania alone will approach $3 billion in annual revenues in a few years when all of the prospective licenses are up and running.

Also note this difference: Strip-centric hotel/casino operators MGM Mirage (NYSE:MGM), Wynn Resorts (NASDAQ:WYNN), and Las Vegas Sands (NYSE:LVS) all regularly include the hotel RevPAR (revenue per available room) metric in their quarterly earnings reports. In contrast, that metric is a relative afterthought to Las Vegas locals operators Station Casinos and Boyd Gaming (NYSE:BYD), as well as regional operators Ameristar Casinos (NASDAQ:ASCA), Isle of Capri, Penn National Gaming, and Pinnacle Entertainment.

Gaming Revenues




Las Vegas Strip









Southern Indiana



St. Louis



Kansas City



Geographic diversity should reduce cyclicality going forward. Note that after 9/11, it was the tourist-reliant Strip market that took the bigger hit. Some excerpts:

  • From MGM Mirage's Q3 2002 report: "Quarterly comparisons are unique in this period due to the impact of the events of September 11, 2001. Results prior to September 11 were very strong, while the events of September 11 had an immediate and profound impact on the Company's operating performance."
  • From Harrah's (NYSE:HET) Q3 2002 report: "These results again proved the value of geographic diversification, and we benefited from favorable comparisons with the 2001 third quarter, when visitation to Las Vegas declined sharply due to the Sept. 11 terrorist attacks."
  • From Ameristar's Q3 2001 earnings report: "Since the Company's customers reside primarily within a 100-mile radius of the Company's properties, revenues were not materially impacted by the slowdown in air travel resulting from the tragic events of Sept. 11, 2001."

Fighting gas prices with demand
Gas prices have been on the rise, taking precious dollars out of prospective gambling patrons' pockets. On Feb. 7, 2003, the price of a gallon of gas hit a 26-month high at $1.75. By September 2005, the price reached $3.15 a gallon. Yet across the board, almost market by market (with the big exceptions being those affected by Hurricane Katrina), casinos have produced record results the whole way, and continue to do so.

I think there are several reasons for this.

1. The casinos are closer to home. With industry expansion, many casino patrons live not just within a 100-mile radius of their regular casinos, but within five, 10, or 20 miles. What's an extra $1 or $2 per trip when you expect to spend $30 per trip?

2. Gaming demand is at an all-time high. Vegas has created its own demand. Moreover, the spread of gaming into new jurisdictions has both removed the stigma of gambling and further promoted Vegas. It's different when you have a business where your patrons have a chance to win money. The surge in the popularity of poker hasn't hurt, either.

3. Relaxing of regulations. This is related to the above point. As states have relaxed regulations in a number of ways -- removing cruising requirements, raising betting limits, etc. -- casino operators have poured billions of dollars into next-generation riverboat properties, helping to boost demand.

4. The industry is still maturing. It's possible that the effects of the rising gas prices are there, only that gaming demand is so dynamic that market-by-market revenues continue to climb.

5. The pain is yet to come. It's also possible that the industry is due for a big hurt.

It's a slightly different game
I think the game has changed a bit. In my opinion, the view that the gaming industry is "highly cyclical" is largely a function of the prominence of the cyclical hotel business in Las Vegas. That said, as the gaming business becomes increasingly geographically diverse and local, I expect that the industry as a whole will be less sensitive to cyclical effects than it has been historically.

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Fool contributor Jeff Hwang owns shares of Ameristar Casinos. The Fool has an ironclad disclosure policy.