Is Station Casinos (NYSE:STN) a buy? The company certainly thinks so.
The most intriguing aspect of Las Vegas locals champ Station Casinos' second-quarter earnings report wasn't the earnings figures themselves, but thecompany's $472.7 buyback of 6.3 million shares of common stock during the quarter. Even the buyback itself wasn't especially remarkable -- except that the company did so while letting its debt-to-cash flow ratio balloon to a hefty 5.2:1.
You see, it's apparently quite fashionable to be bearish on the Las Vegas locals casino market these days. The chatter centers around a number of topics: Existing home sales aren't quite as robust as they used to be; gas prices are eating away at gamblers' budgets; and everybody expected Station Casinos' chief rival Boyd Gaming (NYSE:BYD) to disappoint because of the increased competition in the market from Station's new Red Rock Resort and Spa, which opened during the quarter. In addition, South Coast -- the property which Boyd just opened in December 2005 -- has been underperforming amid these supposedly dire conditions, so much so that Boyd has found itself willing to sell it after only two quarters of operations (Well, at least that much is true!).
Yet Station Casinos, a company with a relatively large $3 billion in long-term debt, compared to $550 million to $565 million in estimated EBITDA for 2006 -- not to mention $90 million in cash on its balance sheet -- has found the nerve to spend half a billion dollars buying stock.
Clearly, the company sees things differently.
A different view
Here are some key points:
1. Station Casinos CFO Glenn Christenson, from the Q2 earnings conference call (transcript provided by StreetEvents): "The macro market continues to be very robust at near record levels, and as we look at several consumer metrics, all continue to be vibrant. While we're cognizant that there are higher gas prices and higher interest rates, thus far we've not seen any meaningful impact on our operations, and our guidance for Q3 and the balance of the year considers these facts."
2. While existing home sales may be on the decline, and population growth may be slowing, the company says that new home sales are on the rise, population growth is still robust by any measure (40,000 new residents during 2006 through June), and job growth continues. Las Vegas remains the fastest-growing community in the country, and baby boomers are now retiring.
3. Major Strip projects will bring permanent jobs in the long term, but also construction jobs in the short term, all of which will increase the target market for locals casinos in Las Vegas.
4. The company is positioned for significant growth. Between land held for development and advances to the company's tribal partners, Station Casinos says that it has between $1.172 billion and $1.594 billion ($19.03 to $25.88 per share) at fair market value in assets that will be converted into cash-generating operations after 2008. That's in addition to the just-opened Red Rock Resort, the master-planned expansions at several of the company's other existing Las Vegas properties, and the Aliante Station joint-venture project planned to open in 2008.
5. The stock is cheap. We'll get to that in a minute.
Q2 earnings are all right
Before we get into the valuation, we should talk briefly about the earnings. Adjusted earnings in the second quarter fell from $0.66 per share last year to $0.61 per share this year, short of the $0.63-per-share analyst estimate. However, the company maintained its EBITDA guidance for the rest of the year and 2007 as well, suggesting that the business side of things is just fine. Red Rock, which opened April 18, was the star, driving a 13% increase in EBITDA to a record $134 million. Revenues increased 28%, to $305 million, for the company's entire major Las Vegas operations, excluding the jointly owned Green Valley Ranch.
The introduction of Red Rock did weigh on margins, as new properties typically do. The EBITDA margins at Station's major Las Vegas operations (again, excluding Green Valley Ranch) were down to 37.5% during the second quarter, from 41.1% last year. Construction disruption at two of those properties, plus the high-end Green Valley Ranch, probably didn't help much, either.
Is the stock cheap?
That depends on how you look at it. The company expects EBITDA to climb from between $550 million and $565 million in 2006 to between $630 million and $670 million in 2007 -- the first full year of operations at the flagship Red Rock. And with the master-planned expansions complete at the Fiesta Henderson, Sante Fe, and Green Valley Ranch casinos by mid-2007, phase 2 of Red Rock complete by the end of the year, and the introduction of Aliante Station in mid-2008, investors can expect another year of robust EBITDA growth in 2008. Moreover, the company sees healthy cash-on-cash returns in the 20% range.
The company expects to finish the year with $3.22 billion in long-term debt. Based on the midrange of the company's 2007 EBITDA estimate and the stock's price of about $57 at Tuesday's close, Station is trading at about 10 times 2007 EBITDA. However, if you back out the value of the land held for development and advances to the company's tribal partners of $1.172 billion to $1.594 billion -- we'll call it $1.4 billion -- then the company is trading at only about eight times 2007 EBITDA.
If you look at it that way, I think the stock is a bargain. Station Casinos is the best player in the most attractive locals gaming market in the country, with the highest margins and among the highest returns on capital in the industry, a healthy growth pipeline, and a lock on most of the few remaining sites in the Las Vegas locals market that can be developed for gaming. The company also has a potentially lucrative business managing casinos for Native American tribes a la Lakes Entertainment (NASDAQ:LACO). What's not to like?
A gaming basket
At recent prices, there are a number of other companies that I like in the gaming industry, including Motley Fool Hidden Gems selection Ameristar Casinos (NASDAQ:ASCA), Harrah's Entertainment (NYSE:HET), and MGM Mirage (NYSE:MGM). I have mixed feelings about Boyd, another potentially dirt-cheap stock with an inside edge on the Las Vegas locals market (and the Las Vegas Strip as well). But at this point, I think Station Casinos has more upside than the much larger Harrah's and MGM Mirage, and it's a safer bet than Ameristar.
In my opinion, Station Casinos is certainly worth a deeper look. Investors concerned about being too heavily concentrated on a single gaming market (Las Vegas) might consider owning a basket of four or five stocks.
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Fool contributor Jeff Hwang owns shares of Ameristar Casinos. The Fool has a strict disclosure policy.
