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The best odds in Las Vegas
Sin City is growing like crazy and its casinos are doing red-hot business. Skip the flashing lights and $7.95 prime rib and head straight for the real money: Vegas stocks.
By Jim Jubak
When the going gets tough, the tough head to Vegas.
In spite of -- or more likely because of -- higher gas prices, worries about Iraq, an up-and-down stock and bond markets and a weak dollar, the Las Vegas gambling economy is on fire.
Because of that, 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. If youre willing to roll the dice, a gaming company that caters to Vegas locals might prove an even better bet.
How hot is Vegas? When I stayed there in early May (on business, I assure you), the hotel was so jammed that it took room service 75 minutes to deliver my breakfast. The taxi lines at the airport were the longest Ive ever seen. And I live in New York, the city that invented long taxi lines.
But youd probably like some less impressionistic evidence, right? Try this.
- April saw 3.5 million passengers moving through Las Vegas McCarran International Airport, a new monthly record. With the year-to-date count at 13.2 million, up 15% from last year, the airport is on track to break the all-time annual record of 36.9 million passengers set in 2000.
- Year to date, the average room rate at the big hotels on the Las Vegas Strip is up 35%, and those higher rates arent keeping anybody away. So far this year, Caesars Palace has had 14 sell-outs and the Bellagio 11. The pace doesnt seem to be slowing either: The Mandalay Bay had four sell-outs in April and seven in May as of May 24.
Dont bet on the Vegas economy crapping out either this year or next. Much of the record air traffic and hotel bookings is a result of the return of the convention business, and forward bookings show that the trend should stay strong into 2006. A number of hotels located on the Strip have just completed major new convention centers that are now are just coming on line. The convention business brought 1.5 million people to Las Vegas in 1989 who spent $1.1 billion on hotels, gambling, food and incidents. Last year 5.7 million people attended conventions in Las Vegas, spending an estimated $6.5 billion.
That building boom is now drawing to a close, which means less inconvenience for travelers and more rooms, casino floor space and convention exhibition rooms. The upside for investors: a building low means the supply of rooms and the number of new casinos should stay near current levels into 2005. And room rates wont be pressured.
The stocks of the big three hotel and casino companies that dominate the strip, Mandalay Resort Group (MBG, news, msgs), MGM Mirage (MGG, news, msgs), and Caesars Entertainment (CZR, news, msgs) were up strongly in 2003 and are up roughly 20% each so far in 2004. The stocks, however, still arent expensive: Mandalay Resort Group trades at 23 times 12-month trailing earnings and 16 times projected 2004 earnings per share.
Related news and commentary on MSN Money
That seems reasonable, considering the almost unsinkable growth in gambling in Las Vegas. Since 1971, the only years showing a decline in gaming revenue for the greater Las Vegas area are the post-terrorist attack years of 2001 and 2002, according to research from the Birmingham, Ala., investment house Sterne Agee & Leach. Even the declines in those years were modest, just 0.5% and 0.1%, respectively. The stocks have even pulled back in the last month anywhere from 2% to 10% on weakness in non-Las Vegas gambling stocks.
So heres my take on the big three plus one slightly unusual casino operator, Station Casinos (STN, news, msgs), that caters to local gamers.
MGM Mirage owns the high-end market
The company owns 16 casinos in the United States and Australia, but the reason to own this stock is the companys dominance of the high-end Las Vegas hotel/casino market. MGM owns seven hotel casinos on the Strip that, together, account for 60% to 70% of the high-end gaming market.
MGMs strategy has been to constantly upgrade existing properties to push the definition of high-end service and amenities on the Strip and to acquire and upgrade new properties to that luxury standard. That has enabled the company to grab more than its share from such non-gambling sources as retail and restaurants. The continuing upgrade to rooms and retail outlets at the companys 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. Wall Street itself seems decidedly uncertain about those estimates with the range for 2005 reaching from a low of $1.87 earnings per share to a high of $2.70. (The consensus of 18 analysts is $2.36.)
Mandalay Resorts Group strong in conventions
Mandalay owns 11 properties in Nevada, but what makes its stock a potential winner are its three hotels along the Mandalay Mile: the Mandalay Bay, Luxor and Excalibur. In the last few years, the company has spent $1.5 billion to add 1 million square feet of convention and meeting space (at Mandalay Bay), 90,000 square feet of retail space (between Mandalay Bay and Luxor), and 1,117 rooms in THEhotel, an all-suite tower hotel rising over Mandalay Bay.
The expansion has cut into cash flow and piled on debt. Free cash flow dropped to a negative $174 million in the fiscal year that ended in January 2004 from a positive $202 million a year earlier, and long-term debt climbed to $3 billion in January 2004 from $2.6 billion in January 2001. But the companys 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.
Theres tremendous leverage in the high-end market: A dollar more in annual average room rates translates into about 6 cents in annual earnings per share. As a result, estimates Legg Mason, free cash flow over the next few years should climb to $200 million to $300 million annually. That extra cash should allow the company to pay down debt, repurchase its stock shares and maintain or increase the current dividend of $1.04 for a recent yield of 1.9%.
Caesars Entertainment making a turnaround
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 (HLT, news, msgs). Hilton acquired Ballys, 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 where properties didnt cooperate on the basics like purchasing. Worse, they competed for customers.
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. The new Caesars will boast 30,000 square feet of new gaming space, a 175,000-square-foot retail expansion, a new hotel tower and convention center. 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.
Station Casinos loves those locals
Unlike the big three that rule the Vegas Strip, Station Casinos doesnt cater to out-of-town gamblers or convention-goers. Instead, the company goes after the local gambler, and the stock is therefore a play on continued growth in the Vegas metropolitan area, especially the citys suburbs. Here, the news is good: Vegas continues to grow by 6,000 to 8,000 people a month, and the local unemployment rate, 4.4% in April, is about 1.3 percentage points below the national average.
The company plans to use its ample cash flow from operations -- $197 million in 2003 -- to keep adding new casinos and hotels to serve this market: Chico, Gun Lake and Red Rock Station in 2005, for example. 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.
With this column Im adding Station Casinos to Jubaks Picks with a target price of $59 a share by December 2004. With the strength in the Vegas gambling market and population trends in this companys favor, I dont think its too much of a gamble, even in the current stock market.
Changes to Jubak's Picks
Buy Station Casinos
Station Casinos (STN, news, msgs) bucks the trend by building hotels and casinos off the Las Vegas Strip and catering to locals rather than out-of-town gamblers. The companys bet on the local economy seems a good one: Las Vegas is adding 6,000 to 8,000 new residents a month, and, for 2004 through April, Nevada is showing 50,000 new jobs. By building off the Strip in such thriving sub-communities of Las Vegas as Summerlin and along Interstates 15 or 215, the company buys high traffic sites at much lower prices than real estate on the Strip commands. Thats helped Station Casinos hit its target of a return on investment of 20% in the first two years for its new casinos and hotels. As of May 28, Im adding Station Casinos to Jubaks Picks with a target price of $59 a share by December 2004.
New developments on past columns
5 stocks that could soar if rates stay low
Engineered Support Systems (EASI, news, msgs), which I first wrote about in June 2003, just keeps chugging -- no, make that racing -- along. On May 25, the company said it earned 66 cents a share for its third quarter that ended on April 30, up from 34 cents a share in the same quarter of 2003. That near-doubling of earnings wasnt too much of a surprise since Wall Street analysts had projected that the company would make 64 cents a share.
But then, Engineered Support Systems did deliver unexpected news: It raised revenue and earnings forecasts for the rest of fiscal 2004, which ends on Oct. 31. The company expects yearly revenues of about $840 million for the full year and earnings from continuing operations of $2.65 to $2.70 a share. Wall Street had been expecting the company to show 2004 earnings of $2.54 a share and revenues of $787 million. The numbers hold up on deeper study too, in my opinion, as the company was able to show both organic growth from existing businesses as well as improved growth from recent acquisitions. Order backlog increased to $1.47 billion from $1.45 billion at the end of the previous quarter. I think this military logistics and supply company can certainly continue to grow its earnings at a better than 20% annual rate over the next few years. As of May 28, Im raising my target price to $68 by December 2004 from the previous $65. (Full disclosure: I own shares of Engineered Support Systems.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned shares in the following equities mentioned in this column: Engineered Support Systems. He does not own short positions in any stock mentioned in this column.
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