Cash Is King: 2 Good Bets In The Gaming Sector

Includes: ERI, MCRI
by: Scott Fearon

Study after study has shown that most individual investors underperform the indexes. Why? They neglect a few simple rules. The first, as I have repeatedly warned, is never to buy a stock below $5. These junkyard stocks are usually over, not undervalued, and most are heading to oblivion. The second rule is to avoid excessively valued stocks in "cult" industries. Today, social media stocks fit this description, as do Tesla and many companies in the renewable energy space.

So, where should an investor place his or her chips? One place to look is companies paying meaningful (but not excessive) dividends. Historically, those stocks have outperformed the indexes. A second winning strategy is to identify companies that generate big cash flows but trade at low multiples of earnings. I recently traveled to Reno, Nevada, to meet with the managements of two regional gaming companies that fall into that category: Eldorado Resorts (NASDAQ:ERI) and Monarch Casino (NASDAQ:MCRI). I purchased shares in both companies shortly after those meetings.

Warren Buffett advises investors to be greedy when others are fearful. Right now the fear surrounding gaming stocks is palpable, as evidenced by their low market multiples versus historic valuations. The consensus view of the industry is that it is facing a future of slow to no growth as gaming moves to the internet and millennials shun gambling and gambling-centric vacations.

I think this consensus will be wrong.

Two decades ago, gaming company stocks were wildly popular. Most had price earnings ratios to match. Caesars (NASDAQ:CZR), Wynn (NASDAQ:WYNN), Station Casinos, Harrahs and MGM (NYSE:MGM) were high flying, highly valued stocks. Today, there are fewer publicly traded casino operators. Some went private; others were bought by larger operators. The 2008 financial crisis pushed several major players toward bankruptcy, which further soured investors on this group.

Compounding this perception problem has been the rise of Macau, China. I spent four days in Macau last year. Many of its resorts are replicas of properties in Las Vegas. Two icons - Wynn Resorts and Sands Corp. - have opened copycat versions of their Vegas casinos, using the same names and architectural styles. The only difference is scale. The Macau hotel casinos are 50 to 100 percent larger, as Macau's annual gaming win is over five times bigger than the gaming win from all Las Vegas casinos.

Sands and Wynn now derive 80 percent of their revenue from Macau, which means their investors are essentially betting on the whims of the Chinese Communist Party. That is a very risky play. In recent years, China has cracked down on Macao, with restrictions on player behavior and regulation of the lucrative junkets that generate a large percentage of the region's gaming win.

But not every corner of the gaming sector is a long shot. Closer to home, there are still well-run, profitable, reasonably valued casino operators that receive most of their profits in the US, which brings me back to Eldorado and Monarch.

Eldorado owns and operates seven hotel casinos, with three in Reno and four others East of the Mississippi. Eldorado's just reported pro forma 2015 EBITDA was $160 million. A third of that sum came from Reno. ERI generated ebitda of $3.40/share and currently sells at $11, or a paltry 3.2x EBITDA. The company is leveraged with $891 million of debt, but will pay some down from its growing cash flows.

Monarch has a hotel casino in Reno and another in Blackhawk Colorado (outside Denver). The company reported $50 million in 2015 EBITDA, or almost $2.80/share, and sells for $20, or 7x EBITDA. But Monarch will add a large hotel tower and parking garage in Colorado, which could triple that property's EBITDA from $20 million to $60 million by 2018. If that occurs, Monarch will earn over $5 EBITDA/share.

These stocks are inexpensive, well managed and positioned for healthy growth. Investors might want to bet on them for both short and longer term appreciation.

Link to the original post on the confessions of a contrarian investor.

Disclosure: I am/we are long MCRI, ERI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.