3 Casino Stocks With Significant Upside Potential

Includes: LVS, MGM, WYNN
by: Takeover Analyst

With the domestic economy struggling more than economists anticipated several times in a row, investors ought to consider emerging market exposure. Casinos are one of the best vehicles to capitalize off of growing international demand. They have also fallen unreasonably over the last three months. Las Vegas Sands (NYSE:LVS), MGM Resorts (NYSE:MGM), and Wynn Resorts (NASDAQ:WYNN) are down 27.9%, 20.4%, and 20%, respectively, while the S&P 500 is down only 2.1%. This appears unreasonable in light of LVS and MGM's respective 16.7% and 43.8% 1Q12 better-than-expected performance versus Wynn's 5% miss. Continued momentum will help these firms recover the unduly large amount of shareholder value that has been lost over the last three months.

LVS is one of my favorite picks in the industry. It appears expensive at 22.4x past earnings, but it is actually cheap when you consider that it has a PEG ratio of 0.77, indicating that future growth has yet to be fully appreciated. The 2013 EPS is expected to be $3.10 and then grow 29.3% annually over the next 5 years. If the company realizes $6.70 EPS by 2015 and has a 15x multiple, the future value of the stock would be north of $100.

Of course, a 29.3% annual EPS growth rate over half a decade is highly uncertain. Accordingly, I will factor in an aggressive discount rate of 12%. Even with this aggressive discount rate factored in, the price target comes out to $62.40 - which is in-line with consensus ratings. That means nearly 50% appreciation on top of a 2.4% dividend yield. Investors should be cognizant that the stock has a beta of 3.6 and thus has the potential of generating higher risk-adjusted returns.

MGM carries even greater risk given that it is expected to bleed money and has a beta of 3.7. A 2013 loss of $0.20 per share is expected, and liquidity isn't great under a quick and current ratio of around 1.3. Analysts still rate the casino operator closer to a "buy" than a "sell" according to FINVIZ.com and have a $16.40 price target on the firm. Stifel Nicolaus recently rated the firm a "buy" with a $20 price target. EPS, moreover, was 43.8% better-than-expected in the first quarter. Put differently, investors will have to weigh whether uncertainty is worth the chance of their holdings doubling. I believe it is under the context of broader diversification.

Concerns about the sovereign debt crises also appear unreasonable for a firm that is built off of a loyal demand side. The same type of people who will go gambling in the first place are likely to continue to do so in the future irrespective of federal instability. Moreover, if anything, consumers will have more income to gamble with if oil prices decline as expected. Accordingly, I recommend investors open a speculative long position.

Wynn Resorts is similar to LVS in its brand name quality, but performance has been spotty of late. The company is currently expensive at a 21.3x past earnings multiple and is rated near a "hold" on the Street. Unlike LVS, the firm has a PEG ratio above 1 at 1.32. With that said, growth is more than 1,000 basis points lower than what is expected for LVS on an annual basis while ROE remains 2.2x higher. Like its peers, Wynn is highly volatile at a beta of 2.4 and is thus likely to generate either substantial outperformance or substantial underperformance. In my view, the firm is more likely to experience the latter given positive secular trends in its industry and a sustainable brand name with attractive growth opportunities.

Under current assumptions, the firm would yield 2016 EPS of around $11, which, at a 15x multiple, translates to a future stock value of $165. A 10% discount rate yields a price target that is virtually in-line with the current valuation.

Click to enlarge:

Wynn's various analyst price targets. Source: FINVIZ.com.

At the same time, Wynn has a 2% dividend yield, while offering excellent exposure to emerging markets. As can be seen in the image above, Wynn also has quite high price targets, with Barclays issuing a $176 price target. Accordingly, investors are encouraged to buy shares before the stock swings too high in the upward direction.

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

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.

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