Casino Stocks: A Good Bet

06/04/2004 12:00 am EST

Focus:

Jim Jubak

Founder and Editor, JubakPicks.com

"The Las Vegas gambling economy is on fire," says Jim Jubak, columnist for CNBC on MSN Money. "And the stocks of the big hotel and casino companies that dominate Vegas gambling look like a good bet for investors over the next 12 to 18 months."

"MGM Mirage (MGG NYSE) owns 16 casinos in the US and Australia, but the reason to own this stock is its dominance of the high-end Las Vegas market. MGM owns seven hotel casinos on the Strip that, together, account for 60% to 70% of the high-end gaming market. MGM’s strategy has been to constantly upgrade existing properties to push the definition of high-end service and amenities. The continuing upgrades at its New York, New York hotel casino, for example, has so far paid off; revenue in 2003 was up 23% from 2002. The repositioning of the Treasure Island hotel casino has similar potential. Wall Street analysts are now projecting 55% earnings per share growth in the June quarter and 41% growth for all of 2004. Growth estimates for 2005 at a paltry 8% are, in my opinion, far too low and give this stock plenty of room for upside surprises.

"Mandalay Resort Group (MBG NYSE) owns 11 properties in Nevada. But what makes its stock a potential winner are the Mandalay Bay, Luxor, and Excalibur. In the last few years, it has spent $1.5 billion to add one million square feet of convention and meeting space, 90,000 square feet of retail space, and 1,117 rooms . The expansion has cut into cash flow and piled on debt. But the company’s building boom has resulted in Mandalay owning 23% of all convention space on the Strip and a 15%-to-20% share of the high-end gaming market. There’s tremendous leverage in the high-end market: Legg Mason estimates that free cash flow over the next few years should climb to $200 million to $300 million annually, which would allow the company to pay down debt, repurchase stock, and maintain or increase the current dividend.

"Caesars Entertainment (CZR NYSE), the third-largest hotel casino operator in Vegas, is a turnaround story. The company is just now starting to overcome the legacy of its haphazard business strategy: It started as the gaming division of Hilton Hotels, which acquired Bally’s, which was then spun out in 1998 as Park Place almost simultaneously with a merger with Grand in 1998. Then the new Park Place acquired Caesars in 1999. That resulted in a decentralized company. That all started to change when Wally Barr, a 30-year casino industry veteran, joined the company as CEO about 18 months ago. The physical changes are most obvious at the flagship Caesars Palace hotel casino, which will end a three-year construction project in 2005. Wall Street analysts are projecting earnings per share of 67 cents in 2004 up from just 16 cents a share (thanks to a 28 cents a share loss in the fourth quarter) in 2003.

"If you’re willing to roll the dice, a gaming company that caters to Vegas locals might prove an even better bet. Unlike the big three that rule the Vegas Strip, Station Casinos (STN NYSE) doesn’t cater to out-of-town gamblers or convention-goers. Instead, it goes after the local gambler, and the stock is therefore a play on continued growth in the Vegas metropolitan area. Here, the news is good: Vegas continues to grow by 6,000 to 8,000 people a month. The Wall Street consensus projects earnings per share to grow by 51% in 2004 and 18% in 2005. Given the new projects coming on line that year, I think the estimates for 2005 will turn out to be low. I’m adding Station Casinos to my Jubak’s Picks with a target of $59 a share by December 2004. With the strength in the Vegas gambling market and population trends in this company’s favor, I don’t think it’s too much of a gamble, even in the current stock market."

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