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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 Katrinas 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. Mississippis gaming commission closed 17 casinos the day before the storm hit. Katrina virtually destroyed Biloxi, Miss., the nations third-largest gaming market. The New Orleans market didnt 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 Harrahs 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 Harrahs 2005 estimate by 16 cents a share, while lowering next years projection by a mere 5 cents. Prudential, Merrill and others made similar adjustments to Harrahs and other storm-exposed companies.
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Despite the measured response on Wall Street, Main Street was much less sanguine. Last week alone, investors cut the market cap of Harrahs, 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 hasnt released much information, because its 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 dont 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 Harrahs 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 industrys long-term position. The new or refurbished properties will generate higher margins than those they replaced.
Obviously, Im 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, its 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 Capris 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: Its 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 wont be that severe. Meanwhile, the industrys 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 Harrahs, 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.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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