Boyd Gaming Still Has Potential Upside

| About: Boyd Gaming (BYD)

I have followed the casino stocks for almost twenty years now. The Las Vegas focused companies such as Boyd Gaming (NYSE:BYD) and MGM Resorts (NYSE:MGM) have been the stocks that have been hurt the most by the recession. The Las Vegas economy from 2003-2007 was the most credit bubble driven economy in America so when it crashed, it fell harder than anywhere else. I actually lived in Las Vegas from 2001 until 2005 so I have followed Boyd Gaming for twelve years now. Boyd's focus in Las Vegas is the off strip casinos that cater to the Las Vegas residents (locals), employees in the gaming industry and the convention visitor business. They did a merger back in 2004 with the more upscale local's casino player Coast Casinos and when I discovered the numbers behind the deal, I couldn't believe what I found. I found that their earnings might go from like .50 cents to $2.00 per share. For months I was telling everyone to buy Boyd Gaming's stock and hardly anyone would listen to me. Over the next two years as the Vegas economy heated up and the national housing bubble began to take hold, money flooded into Las Vegas. The town began sizzling from the credit bubble fueling construction, jobs, new residents flocked to the city by the thousands and housing prices exploded. With everyone making such easy money, their casinos were raking in huge profits. Their earnings exploded more than I expected to like $3.25 per share and the stock exploded from $19 to $51. I had estimated the stock might go from $19 to $30 but it went parabolic and shot up to over $51.

This same exposure to the Las Vegas market is what brought down the company as they tried to expand and embark on a multi-billion Vega strip project. Then he bubble burst in 2007 and the Las Vegas economy crashed, construction stopped, the workers dependent on construction and tourism were devastated, housing prices fell 60% plus. Unemployment soared to over 14% and the casino sector crashed and has stagnated for almost five years now. At the same time Boyd had imploded its only Vegas Strip property (the very old Stardust) and started building a multi-billion dollar strip project. In a lucky twist of fate when the recession began, the banks cut off financing to the $4.1 billion project and Boyd was left with land and the beginning of the buildings shell it had already spent a couple hundred million in beginning construction. However this was actually a positive because if they went forward the company would have been in bankruptcy because it was such a large project, it would have never made it to completion. If it had opened in the worst economic environment possible, it never would have been profitable because there developed too much high end capacity for rooms on the strip, so the room rates have fallen and competition is stiff.

That brings me to why I'm attracted to the stock today. In their earnings conference call three months ago they made announcements regard the divestiture of assets and their impact on earnings. They announced they sold their Las Vegas Strip land holdings and unfinished project for $350 million cash to Genting Holdings of Malaysia. After paying off obligations they cleared $150 million in cash and are using those proceeds to reduce debt. This project sitting there idle was costing them $20 million per year in taxes, insurance, etc. so it was drag on their earnings of about 20 cents per share each year. They also sold a pari-mutual betting operation in Florida for $65 million that they were losing $4.5 million per year or about 5 cents per share. When they repay the $150 million in debt that will remove $10 million in interest payments or another six cents in earnings savings. These three moves alone will have the effect of a thirty one cent positive swing in their net income per share. See their earnings conference call dated March 4,2013.

There is also now evidence that their Las Vegas locals market has now stabilized and with a main rival pulling back from over generous marketing efforts this business will slowly get better and return to profitability. They confirmed a strengthening in the Las Vegas market and were positive going forward on Las Vegas on their last earnings conference call dated May 2.

Boyd is tied heavily to business that is derived from the Las Vegas strip so as it is now recovering as cited on the most recent MGM earnings call, eventually Boyd will benefit too. Long-term there is now about $5 billion in construction that will occur in the next three years that will be beginning, unemployment is now below 10% and housing prices are up 19% from a year ago. If the national economy gets better and the convention business strengthens by this fall, this company will should become steadily profitable again. This was confirmed in their last earnings report when excluding merger charges, the company has actually already returned to profitability.

Management has stated that they intend to make more moves to sell non-core assets and continue to reduce the debt level of the company. The Boyd family and management own over 25% of the stock and after years of a pathetic stock price, I think they finally are serious about improving their business profile and the stock price. So far, I have only discussed the Las Vegas business of Boyd which when I followed them years ago used to be about half of revenue. However they also have a significant Mid-West business consisting of eleven casinos, five of which were just added in a recent acquisition. After this acquisition the Las Vegas business has been reduced from 34% to only 24% and the Midwest business has increased from 35% to 54%. They also are the dominant player in Atlantic City with a 100% interest in the Borgata which has the leading market share and profits in that market.

The Atlantic City market has been declining and struggling. This acquisition reduces their exposure to A.C. from 31% down to only 22%. There is a significant positive on the New Jersey angle in that the Borgata now offers gaming by electronic device in your room which is just newly legal. More importantly than that they just legalized gaming for any resident inside of the state. I think that is worth between $1-2 per share over the next few years. That is because the Borgata has a large advantage because they have the largest market share at almost 35% in New jersey, the best database and highest quality customer base in that market.

The last reason I like the stock was they just completed an acquisition of Peninsula Gaming which added five casinos in the mid-west to their portfolio. This deal kind of reminds me of the Coast Casino acquisition because while the assumed a lot of debt, they only paid a couple hundred million in cash. Peninsula diversifies them more into stable mid-west markets with more limited competition, low tax rates and higher profit margins. The company also has a new property south of Wichita, KS. That is a big money maker. This acquisition will help improve profit margins; EBITDA and assist in helping the company become profitable again. I think this acquisition has also added $2-4 per share in value.

The rest of the regional casino stocks have had significant recoveries already. Similar companies like Penn National (NASDAQ:PENN) are at all-time highs, Pinnacle Entertainment (NYSE:PNK) is buying Ameristar Casinos (NASDAQ:ASCA). Boyd Gaming until this year has been left out because they are viewed as primary a Las Vegas and Atlantic City dependent company. Those two markets have their own challenges but we know they actually only represent half of the EBITDA of the company post-merger. We know they are taking steps to deleverage and turn the company around. We also know they have potential catalysts of online gambling in New Jersey and online poker in Nevada. So the general consensus about the company is somewhat mistaken, expectations are still fairly low and potential catalysts to surprise investors are in place.

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Now the price of the stock has rallied from $8 to $14.50 in just a few months. It now has pulled back and trades at $12.60 or the equivalent of 1.88 times revenue. At the current price many of the more obvious catalysts that I mentioned in this article have now somewhat been priced into the stock. The final catalyst that will drive the stock to probably at least $17.50 which would be almost a 39% plus gain in the next twelve months is the improving fundamentals in the national and especially the Las Vegas gaming market. I'm assuming the company has revenue of $2.95 billion which is in line with the current analyst's consensus. I also now am fairly sure that the company which was expected to lose thirteen cents per share in 2013 will actually probably report a profit of five to ten cents per share. This is because of the net change from a loss of 35 cents that has been removed in the three specific items I mentioned above and the strengthening of their fundamental markets. The scenario where the company was losing money consistently to returning to profitability will be the catalyst I expect to expand the valuation based on its enterprise value.

I expect this scenario will cause the valuation to surge from 1.88 times revenue to 2.5 times revenue. Domestic casino companies used to regularly trade at three times revenue so this is not an unrealistic assumption. This is also possible because Boyd is a highly leveraged company and currently still only has a $1.1 billion market cap. It is also much easier for a company with a $1.1 billion market cap company to surge 35% plus than an $8 billion market cap company to have an equivalent move. The stock has large insider ownership of 35.75% and is still heavily shorted with sixteen 16 million shares short or 29.25% of the float. Finally the stock has now pulled back 13.1% from the $14.50 high just made within the last thirty days.

Disclosure: I am long BYD, MGM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.