Why Dover Downs' Days Are Over

| About: Dover Downs (DDE)

Many of you may not be familiar with Dover Downs Gaming & Entertainment (NYSE:DDE). Its operations include Dover Downs Casino, a 165,000-square-foot casino complex featuring popular table games such as craps, roulette and card games; slot machine offerings, such as multi-player electronic table games, and a race and sports book operation; the Dover Downs Fire & Ice Lounge; Doc Magrogan's Oyster House; and Frankie's Italian restaurant, as well as several bars, restaurants, and four retail outlets. The company's operations also include the Dover Downs Hotel and Conference Center, a 500-room AAA Four Diamond hotel with conference, banquet, ballroom, and concert hall facilities; and Dover Downs Raceway, a harness racing track with pari-mutuel wagering on live and simulcast horse races.

Dover Downs has a tough road ahead, which is why I am recommending investors take a short position in the company. Dover Downs has a great risk-reward for investors compared with other potential short candidates. Take for example, Pandora (NYSE:P) or Zynga (NASDAQ:ZNGA), both trading at high valuations compared with Dover Downs. Why short Dover Downs compared versus Pandora and Zynga?

The market still believes that these companies have massive growth ahead so any investor looking to take a position will have to compete with widespread speculation. Dover Downs, however, is different. The stock trades at a current P/E of 20, but has declining growth ahead.

Here is why growth will decline:

  • Competition
  • Delaware Tax Code
  • Payout Ratio

The State of Maryland supplies Dover Downs with nearly 50% of its customers. Recent gaming laws in the state have allowed slot machines to be built. Penn National Gaming (NASDAQ:PENN) recently built the Hollywood Casino in Perryville, MD.

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This opening of the casino by PNG means that residents in Delware may actually opt to go to the casino in Maryland than their own state due to proximity.

The Hollywood Casino in Maryland is not the only one in the state. This summer, another casino is set to open in Maryland. The Maryland Live is a $500 million casino built in Anne Arundel Mills. Maryland is seeing a large growth in gaming and that will be a problem for Dover Downs. It's also important to note that Pennsylvania has also eased its gaming laws in the past few years.

Tax Code

CEO Dennis McGlynn has stated that under the current tax code Dover Downs could see a massive decline in profitability. For example, last year the company had to take on debt to pay licensing fees. The industry is heavily regulated by the government and that causes problems for casinos.

Payout Ratio

Dover Downs is a very shareholder-friendly company. The stock pays a 5% dividend. However, the issue has now become the lack of cash flow it has to sustain that dividend. The current payout ratio stands at 100%. Dover Downs will need to cut the dividend in order to build up its balance sheet. With such a high payout ratio, the company would have little to no cash left over for investment in the business.

If you want exposure to smaller casino companies, I have three in mind that would all be better buys than Dover Downs.

Penn National Gaming is a very diversified casino operator. With the recent change in gaming laws, we have seen management at PENN take a strong initiative by being ahead of the curve. The stock trades at a forward P/E of 18.

Churchill Downs (NASDAQ:CHDN) is a great play due to its expansion phase. The company just recently expanded its facility in Mississippi, and has been reinvesting plenty of cash back into the business. Churchill Downs trades at a forward P/E of 19 and pays a 1% dividend.

While Boyd Gaming (NYSE:BYD) isn't as big as the other two companies, the nice thing about this company is that its casinos are located in major gaming capitals. Boyd has casinos in both Las Vegas, and Atlantic City. It also has a large casino in Biloxi, which is another large gaming town. The company has been generating plenty of cash as well and is a good play on the U.S. economy. The stock trades at a forward P/E of 32.

All three of these companies are profitable and diversified. The big issue with Dover Downs is that the company is relying on one property and that causes issues when the environment, whether it be regulatory or competition, is not so favorable.

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