Slots and Drinks

01/13/2006 12:00 am EST

Focus:

Paul Tracy

Editor, The StreetAuthority Market Advisor

Supported by a team of highly talented analysts, Paul Tracy offers an incredible variety of consistently well-studied and in-depth research. In line with this diversity, his top conservative play is a US slot maker, while his favorite speculation is a Polish liquor distributor.

"Our top ‘more conservative’ pick for 2006 is International Game Technology (IGT NYSE). The firm is the world's largest slot machine maker. In addition to sales, IGT generates half of its revenues by leasing machines to casinos in exchange for a percentage of the net win. This provides the firm with a recurring stream of high-margin revenues. Thanks to steady expansion in recent years, IGT now draws income from nearly 40,000 machines installed throughout casinos in key gaming markets around the globe. More recently, IGT has also diversified its operations into other promising new technologies, including high-tech player tracking systems.

"Thanks to a stringent regulatory environment, IGT enjoys high barriers to entry and must contend with only a handful of rivals and has a towering lead, producing more than two out of every three machines found in North America today. With deep pockets and steady cash flows, the company has been able to spend nearly twice as much on research and development as its closest competitors. In a recent poll seven of the top ten most popular video slots were introduced by IGT and among video poker players, all five of the top spots were awarded to IGT products. With a knack for developing games that resonate with players, IGT should continue to remain the clear leader in this high-growth industry for years to come.

"The shares stumbled throughout 2004 and 2005 due to sluggish domestic slot machine sales. However, we believe the core North American market is poised to grow substantially over the next few years as cash-strapped states embrace gaming as a way to generate millions in tax revenues. Add to this the impact of strong international salesMacau is billed by many to be the next Las Vegas the international outlook is bright and overall earnings are expected to increase at a healthy 15%+ annual clip going forward. IGT has been a portfolio jackpot for many over the years, and odds are excellent that its winning streak will continue.

"Our ‘more speculative’ play for 2006 is Central European Distribution (CEDC NASDAQ). Although based in the US, this company is Poland's largest liquor importer and distributor. It distributes liquors to over 30,000 businesses. CEDC has no effective competition in the Polish market right now and barriers to entry in this market are very high. Although the firm started out exclusively in the liquor distribution business, CEDC has moved aggressively into the distillation market in recent years, buying up several Polish vodka makers. In fact, on the heels of several major acquisitions in 2005, CEDC is now the world's fourth-largest vodka maker.

"Eastern Europeand Poland in particular are attractive growth markets. Poland was admitted to the European Union back in 2004 and foreign trade has since increased dramatically and is set to explode even further in the years ahead. CEDC should be a major beneficiary of this trend. One of the most important economic reforms the country implemented was the removal of punitive tariffs on imported liquors. As a result, after May 2004, CEDC reported an immediate 40% jump in sales directly attributable to the removal of that tariff. Prior to that date about 70% of the company's sales came from domestically produced spirits.

"Since that time, however, the mix has been gradually shifting toward imported liquors. CEDC has catered to this trend by negotiating contracts with some of the best-known foreign producersincluding Johnny Walker scotch and Jose Cuervo tequila to ensure sufficient supply at favorable prices. The good news is that these products carry far higher profit margins than liquors produced in Poland. Therefore, as the nation becomes wealthier and consumers gradually shift their spending habits to reflect the reduced tariffs, CEDC's business mix should continue to shift more in favor of high-margin imported liquors.

"CEDC should have no trouble posting 15-20% annual growth over the next five years. In addition, it's worth noting that liquor demand tends to be very stable, even in weak economies. As such, the firm's growth should remain fairly stable over time. Even better, the company's aggressive expansion into the distilling business could offer upside to those estimates. E arnings should handily exceed $2 per share in 2006 and could approach $5 per share by the end of the decade. Assuming Wall Street values the firm at a multiple of 20 times earnings, this stock could easily trade well north of $100 within the next few years."

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