Outlook for Gaming Operators

 |  Includes: ASCA, BYD, HET, ISLE, PENN, PNK
by: The Wall Street Transcript

On January 28, The Wall Street Transcript interviewed Nicholas A. Danna IV, a Vice President at Sterne, Agee & Leach Group, Inc., where he is the Senior Equity Analyst for the leisure and entertainment industry and primarily focuses on casino operators. Key excerpts follow:

TWST: I guess the key issue is, where do we go from here? What are you looking at for 2008?

Mr. Danna: For 2008, we look for a couple of things. The first is that we think there are going to be some properties that were part of these leveraged buyouts that come back to the market. The acquisition or the buyout of Station Casinos was just completed, the acquisition of Harrah's (HET) will be completed in the next month or two, and the acquisition of Penn National Gaming (NASDAQ:PENN) will happen in the middle of the year. When you combine those acquisitions with the troubles that Columbia Sussex is currently having (they recently lost their license in Atlantic City), we believe that some of the Columbia Sussex properties as well as some of the Harrah's properties will likely be sold. I think that will create some opportunities for the regional operators to expand their portfolios. I think the other thing that we will see is the opening of some new properties as well as the expansion of some properties. I think that could drive results for those specific companies. Pinnacle Entertainment (NYSE:PNK) has just opened a new property in downtown St. Louis and Ameristar Casinos (NASDAQ:ASCA) has a couple of expansions opening between now and the end of 2008. So I think, again, it's going to be a case of being stock-specific, company-specific. I think certain markets will continue to see competition that could impact the results. So I think you must be stock-specific and focus on companies that have the ability and the privilege to either build new casinos or to expand existing casinos in quality markets.

TWST: As we look at 2008, how much of an impact is the slowing of the economy going to have on the space?

Mr. Danna: Historically, consumer confidence, gas prices, economic upturns and downturns have not had a meaningful impact on gaming spend. It's tended to be much more resilient than most consumer businesses. We are seeing some slowing in the Las Vegas local market. I think the different factor this time than in previous periods is the housing market. Las Vegas is one of the markets where housing was really on fire for a number of years and has now seen a pretty substantial downturn. I think that's having some impact there. But I continue to think gaming will hold up better than most other consumer-related spaces will. Still, we're going to have to focus on specific markets, specific properties and specific companies.

TWST: Given that, what are you telling investors to do at this point?

Mr. Danna: Again, we're entering 2008 reasonably cautious, as we did in 2007. We think that there are some markets where competition is going to continue to plague it for the foreseeable future, but we think that really the way to play it is with companies that have deep development pipelines, strong balance sheets and/or are able to grow through internal expansions. There are two stocks that are our top ticks for 2008. The first one is Pinnacle Entertainment. The basis for that opinion is that they have the best development pipeline of the domestic gaming companies. They plan to open one new casino per year for the next five years; two will be in St. Louis, two will be here in Louisiana, and one will be in Atlantic City. We think the returns from those projects should be adequate enough to drive shareholder value over time. We believe that the current stock price at about $23 basically assigns no value to the development pipeline, so you're essentially buying the existing business and getting the upside from the development pipeline for free.

The second one that we're recommending is Ameristar Casinos. The reason for that one is we believe it has similar characteristics to Penn National Gaming. Both companies have historically been buyers of assets and have improved the performance of those assets over time. Ameristar tends to be best in class in its markets. They have an expansion program where they're upgrading or expanding virtually all of their properties and they are able to do that through free cash flow. When companies are able to fund this type of expansion program through free cash flow, the incremental EBITDA comes online with no change to the debt balance. That typically has a meaningful impact on the stock valuation.

TWST: Are there any names in the space that you worry about at this point?

Mr. Danna: There are numerous stocks that we have HOLD ratings on. For a variety of reasons, Boyd Gaming (NYSE:BYD) is one of those we've been neutral on for some time, partially due to what we see as the slowdown in the Las Vegas local market. They get over 50% of their profits from that market. They're also leveraged to Atlantic City with their 50% interest in the Borgata. That market has had its challenges as we chronicled earlier. They're also facing new competition in their biggest riverboat market, which is Northern Indiana. That property is facing new competition from a Native American casino in Michigan. So they have a number of competitive challenges that they're going to have to work through in the near term. Longer term, we think there are some positive things in terms of new developments, especially the one they are doing on the Las Vegas Strip, but again that's many years out.

The other one that is turning into somewhat of a turnaround story but we think it's going to take some time to play out is Isle of Capri (NASDAQ:ISLE). That's one we actually highlighted last year as a stock that we were cautious on. They had a very difficult 2007. I think the stock is 50% or 60% off of its 52-week highs. The results there have been challenging. However, they do have a new management team in place. They are re-evaluating everything they do from the Isle of Capri brand to where they spend their capital dollars, to how they position themselves in markets, to what markets they exactly want to be in. So we are seeing the beginning stages of a turnaround, but I think that turnaround is going to take some time. Until we see a bit more tangible evidence of that turnaround taking hold, we're still cautious on that stock.