Betting Against the House: Going Short on Casinos

by: Nicholas Pardini

In the first two parts of my series on "sin stocks" I examined the potential upsides of tobacco, alcohol, and gun companies. However, with casinos and gambling stocks, I am betting on the short side. With increased competition from local Indian run casinos, high oil costs, lower domestic income and travel budgets for Americans, and dangerously high debt levels, and shrinking margins, U.S.-based gambling stocks are trading at a point of weakness. In addition, the asset value of the casino's real estate (particularly in Nevada) has significantly declined since 2006 while the firm's liabilities have not. This factor has created significant losses in the companies book value of its equity and gives many of these companies some of the highest debt/equity ratios in the market and solvency risk. Here is a list of three of the most weakly positioned stocks in the sector.

MGM Resorts International- (NYSE:MGM)- MGM has suffered from the downturn of travel to Las Vegas since 2008 and has less exposure to Macau than its competitors Las Vegas Sands (NYSE:LVS) and Wynn (NASDAQ:WYNN). MGM's growth in Asia is also restricted by the company's high debt levels (4.14 debt/equity ratio) and Chinese regulations that limit travel to their resorts. High gas prices and recently built local casinos throughout the nation has caused tourism to decline in Las Vegas. Losses have declined in the last quarter, but the company still has a -23% net margin and has averaged a 57% loss over the past five years. The one thing going for MGM is the construction of the new, trendy CenterCity district of Las Vegas and the Aria Hotel. However, even this project is dragged down by lawsuits against MGM for joint venture partner Dubai World and the loss of market values of Las Vegas strip condos that the company is selling in the area. Technically the MAC-D and RSI index indicate that the company is somewhat overbought and may head for a downturn soon.

Monarch Casino Resorts Inc. (NASDAQ:MCRI)- Out of all of the gambling stocks listed, Monarch Casino Resorts has the fastest dwindling fundamentals. First it only operates one casino, The Atlantis Casino Resort Spa (in Reno, not Paradise Island). With the increase of Indian gaming options within California and on the Nevada side of Lake Tahoe, California tourist flow to their casino is declining. In addition the local economy in Nevada is weak from some of the nation's largest housing price declines and a nationwide leading 11.9% unemployment rate. Even with a big recovery last year, earnings are still down by an average of 15% over the past five years and technically it is stuck in a solidly bearish channel. All of these signs are bad for MCRI and its Reno location is a structural problem that cannot be fixed as staying home, Las Vegas, or skiing in Tahoe are all better gambling trip options for west coast tourists.

Isle of Capri Casinos (NASDAQ:ISLE)- Isle of Capri Casinos is a gambling company whose target demographic is middle to lower income Americans in poorer regions of the country such as Missouri, Louisiana, Florida, and Iowa. Outside of its Pompano Beach location, none of their casinos are near any major tourist destination, so ISLE relies on local customers for its business. Lower disposable incomes of its lower-mid end target demographic have put profit margins and return on investment capital into the red. ISLE's debt to equity ratio is over five which makes bankruptcy a real issue if the company performs poorly for another year. Technical analysis also indicates a clear breakout to the downside over the past two weeks. Its competitor Boyd (NYSE:BYD) is based out of the same region and equally weak financially as well.

Overall, I am bearish on gambling stocks, particularly those that lack exposure to Macau. The stocks mentioned in the list above specifically are located in poorer parts of the U.S. and have struggled to attract consumers with shrinking budgets. Even with a slight recovery in the economy, disposable income (especially the kind that can blown in a casino) has not recovered with GDP. Isle of Capri is probably the best option on the list to short due the weakness of its customer bases and extremely high debt levels will cause solvency concerns. It will take a major catalyst such as legitimate progress towards legalization of online gambling in the United States to turn the sector around. Based on technical patterns, many of these stocks are overbought and are poised to decline. Until then, take a wise bet and go short on casino stocks (or at least stay away from buying them).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.