08 September 2005

Katrina puts gambling stocks on sale. But what to buy?

I found these AP photos from the following story in the Las Vegas Review-Journal
. Images like these scared significant numbers of shareholders into selling. Arising from this destruction is an opportunity to buy sound companies at a discount.

It seems to me that the Mississippi Gulf Coast can and will rebuild and recover from Katrina. But wait, you say, what about this CNN piece
that discusses the casinos' concern that Mississippi's legal requirement that casinos float might keep them from rebuilding?

Larry Gregory, executive director of the Mississippi Gaming Commission (MGC), hopes to do that, although he's not fully confident that the gaming companies are willing to come back and rebuild their businesses. And there are now some indications that his task is daunting -- particularly if there's no change in the state's 12-year-old gambling law that mandates casinos operate only on water in floating barges.

I think this is a non-issue. Impoverished, now devastated Mississippi desperately needs the tax revenue the casinos provide. I don't think the question is will the barge requirement be changed, but when.

The next question is, Is Mississippi really our main concern for these stocks? Or should we be thinking Atlantic City and Vegas? Check out Robert Walberg's piece from MSN Money:

Street Patrol
Suddenly, casino stocks are a good bet
Images of casinos devastated by Katrina have led to a big sell-off, but investors are overreacting. These gambling firms are now an attractive buy.

By Robert Walberg

Investors tend to overreact during times of crisis, and Hurricane Katrina's aftermath has proved no exception. Images of destroyed Gulf Coast casinos have, naturally, helped drive down the share prices of the companies that ran the wrecked hotels and gaming rooms.

Even before Katrina arrived, those casinos were taking an economic hit. Mississippi's gaming commission closed 17 casinos the day before the storm hit. Katrina virtually destroyed Biloxi, Miss., the nation's third-largest gaming market. The New Orleans market didn't fare much better.

But just as every bet has a winner and a loser, so, too, does Katrina's aftermath create opportunities for gaming companies. If gamblers can't get their fix along the Gulf Coast, at least for now, odds are many of them will find another venue. Hello, Las Vegas. And you can be sure that, eventually, high- and low-rollers alike will find their way back to Biloxi and New Orleans.

With the stocks taking a beating, this is the time for smart, long-term investors to snap up shares of companies that will survive and eventually thrive.

Earnings damage light, stock damage heavy
Gaming companies with big operations on the Gulf Coast include Harrah's Entertainment (HET, news, msgs), Penn National Gaming (PENN, news, msgs), Isle of Capri Casinos (ISLE, news, msgs), Pinnacle Entertainment (PNK, news, msgs) and MGM Mirage (MGM, news, msgs). JP Morgan estimates that the cash loss to these companies will fall in the range of $15 million to $25 million apiece, representing their insurance deductibles for business interruption and property damage. There will be other expenses such as payroll and rebuilding, but the cash hit is relatively small for an industry that typically generates plenty of cash.

Wall Street wasted no time lowering earnings estimates for the companies. So far, however, those adjustments have been relatively modest. For example, JP Morgan took down Harrah's 2005 estimate by 16 cents a share, while lowering next year's projection by a mere 5 cents. Prudential, Merrill and others made similar adjustments to Harrah's and other storm-exposed companies.

Despite the measured response on Wall Street, Main Street was much less sanguine. Last week alone, investors cut the market cap of Harrah's, MGM, Penn National, Pinnacle and Isle of Capri by a combined $1.3 billion. Why the harsh response? Simple: fear of the unknown.

Looking at the pictures of casinos flooded or smashed to bits, investors have no idea how long it will take the industry to rebuild. And the industry hasn't released much information, because it's still too early to fully assess the damage. Nevertheless, it is very obvious that many of the casinos will be closed for much longer than 30 days. In the worst cases, it could be a year or more before properties are refurbished or rebuilt.

Investors also don't have a handle on when, or even if, tourists will return to the ravaged area in pre-Katrina numbers. This should be less of a concern, however, as the casino operators will simply move to new locations if the Gulf Coast region no longer seems safe. As they said in the movie "Field of Dreams," "if they build casinos (here or elsewhere), gamblers will come.

Convention-site arbitrage
In fact, even the loss of revenues in the Gulf region over the next year might not be as bad as many analysts anticipate -- especially for those companies such as Harrah's and MGM that have multiple properties elsewhere, namely Las Vegas. Much of the business in New Orleans and Biloxi comes from conventions, and those conventions will simply move to new locations such as Los Angeles, San Diego, Phoenix and the capital of conventions, Las Vegas.

The same goes for vacationers; they will simply alter their plans and travel elsewhere. I've spoken with three couples over the past few days that were planning trips to New Orleans. All three have now switched their trips to Las Vegas.

Casino companies will also move quickly to build temporary facilities while they rebuild permanent properties. Tough to say exactly how much business they can expect to generate given the region's financial condition, but they will replace some lost revenue. Additionally, look for the casino operators to push hard to win concessions from local politicians regarding moving their properties further inland. Considering the tax dollars being lost from casino closures, local politicians are likely to acquiesce, strengthening the industry's long-term position. The new or refurbished properties will generate higher margins than those they replaced.

Obviously, I'm taking the long-term view of the situation. When you consider that the industry takes in about $450 million per month in revenues from the Gulf region, it's clear that there will be plenty of short-term pain. Pinnacle Entertainment generates roughly 40% of its earnings from the Gulf region. Isle of Capri derives 50% of its revenues from the area. Standard & Poor's already lowered its ratings outlook for Pinnacle to stable from positive, while indicating that it may cut Isle of Capri's debt rating.

The slots will rise again
On the flip side, there are likely to be some short-term winners. International Gaming Technology ( IGT, news, msgs) and WMS Industries ( WMS, news, msgs) both provide gaming equipment such as slot machines -- many of which will have to be replaced after Katrina -- to the casino industry. Casino operators with little or no presence in the Gulf region, such as Wynn Resorts (WYNN, news, msgs) and Station Casinos (STN, news, msgs), are also apt to see improved results over the short term as they benefit from increased traffic in the Vegas area.

Bottom line: It's never wise to make investment decisions during times of stress. No doubt, Hurricane Katrina dealt the industry a losing hand. However, with conventioneers and travelers likely to shift their destinations to other casino-rich areas, the short-term impact on earnings to geographically diversified companies won't be that severe. Meanwhile, the industry's long-term position could actually improve as it wins concessions from politicians regarding where it builds new, more profitable casinos.

Investors never like uncertainty, and the industry is apt to struggle to keep pace with the market over the next three months. But patient, long-term investors should use any weakness over this period to buy well-managed, well-diversified companies such as Harrah's, MGM and Penn National. In the meantime, picking up shares of a gaming-equipment company such as International Gaming Technology would be a wise card to play.

I find Walberg's arguments very compelling. But he throws out a lot of names. Let's take a brief look at the casinos and related companies mentioned in the article, plus a couple of others of interest in the following format:stock ticker/some personal comments, if any/CNBC Stock Scouter score/IBD scores

Unaffected casinos:
AZR - Owner of Tropicana, a revitalized AC property - 7 - 43/67/C+/C/B-
BYD - Owner of Borgata, my favorite in AC that should be better with its upcoming expansion. The most Vegas-like with their style, restaurants (love the Old Homestead), and high-caliber poker room - 4 - 98/69/C+/A/D
WYNN - The "it" casino right now, just expect long lines for a taxi - 4 - 2/22/C+/D/C+
STN - I distinctly remember them owning a casino in St. Charles, MO - 7 - 88/72/C+/A/C
ASCA - I guess these guys own the St. Charles property now - 7 - 80/62/C+/B/D-
PREZ - This was the casino one would end up at after a few too many down in Laclede's Landing. If this means anything to you, you have my pity. And if you happen to own this stock, then you really need a drink. - This is now "traded" on the OTC BB. A share can be had for 26 cents, but today's volume was 721 shares.

Affected casinos:
HET - Harrah's, up until recently, one of Cramer's favorites. I favored their riverboat casinos in Earth City, Missouri when I wasn't studying in law school. - 7 - 87/67/C+/A/D+
PENN - owns casinos in smaller, secondary markets. Cramer began looking away from HET and BYD just before Katrina and put his Mad Money spotlight on this gaming stock. - 3 - 95/85/C+/B/C
ISLE - 4 - 18/47/C+/D/C+
PNK - 7 - 24/79/C+/E/D
MGM - owner of Mandalay Bay, which has diverse scenes at its pools, from a hopping, drunken singles scene on the outermost pool, to a peaceful, reserved feel at the pool for Four Seasons guests. Also owns MGM Grand, where the Cirque du Soleil performs the stupefyingly wonderful spectacle, Ka - 7 - 82/90/C+/B/C+

Other companies that may benefit:
IGT - 8 - 63/16/C+/B/B-
WMS - 7 - 77/40/C+/C/C+

Just because it's only tangentially related:
WPTE - My favorite overvalued television production company. Can you believe that this company has a market cap of around 230 million dollars. I thoroughly enjoy the World Poker Tour, and it is the highest rated show on the Travel Channel, but that's fewer than a million viewers. UPN shows draw more viewers than that - 4 - 18/9/C/na/E

Looking at the numbers, here's what I see that I could possibly like, but don't: AZR is too close to its 52-week high, and has mediocre IBD numbers. PENN has excellent IBD numbers, but is also near its 52-week high, operates horse racing tracks (That sport was finished the second time Garden State Park closed. Probably was finished the first time Garden State Park closed.), and has received recent attention by Cramer.

Here's what I do like, HET seems like a solid company with diverse, top-notch properties. BYD, at around $48, is $11 off its 52-week high. Both these companies were Cramer's darlings during Mad Money Lightning Rounds this summer, but he's since scorned them. I take that as a good sign.

The best stock is IGT, International Game Technology. This $9B company, priced around $27 per share, is $10 off its 52-week high and near its 52-week low of $24.20. The IBD numbers say that its share price has been lagging its earnings growth. And judging from the photo of destroyed slot machines at the top of this post, there's going to be demand for their devices. I'm in complete agreement with Walberg, this is where I would put my money right now. But since I don't have that cash yet, IGT gets a spot on the WershovenistPig Stock Watch List. And just 'cause I'm feeling generous, BYD and HET can have spots, too.

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