While history tells us that the market always does cause surprises, sometimes it is better to bet on a likely scenario than optimistically wait to be surprised. That is what investors call taking a calculated risk. Casino stocks are facing challenging times with most of them clearly boasting some pricy valuation multiples.
Currently, stocks like Wynn Resources (NYSE:WYNN), Las Vegas Sands (NYSE:LVS), Caesars Entertainment (NYSE:CZR) and MGM Resorts (NYSE:MGM) indicate significant cases of overvaluation. Some of them like MGM are already looking to capture the growing interest in online gambling via partnerships, while others like Wynn Resorts are coy of embracing online gaming.
So perhaps the shift to mobility and the growing adoption of online gambling in the U.S. is making some investors a little bit bullish on a sector that seems particularly overvalued. The current scenario points towards market correction in which casino stocks could find themselves at the wrong end of events.
Why Gambling Stocks are Overvalued
From a valuation standpoint, casino stocks seem to be trading at high valuation multiples with no significant backing for the same. Some of them are facing the possibility of filing for bankruptcy, while others carry huge amounts of debt against low levels of free cash flows.
Nonetheless, one company seems to stand out in terms of cash, but still, its high debt could be a major headwind for incremental capital gains.
Caesars Entertainment Is not the only casino company in debt crisis, the rest could follow soon
On May 6, Caesars Acquisition Company “CAC” (NASDAQ:CACQ) completed the acquisition of $2.2 billion worth of assets from Caesars Entertainment, and last month Caesars became a subsidiary of CAC. In return, Caesars Entertainment received a cash consideration of $1.8 billion. Some of the assets acquired include Bally’s Las Vegas, The Cromwell, The Quad Resort and Casino, and Harrah’s New Orleans.
The Las Vegas, Nevada-based Resorts and Casinos service provider has lost more than 50% of its value over the last seven months. The company traded in the region of $26 per share in March, but is now pegged at just over $12. Caesars remains unprofitable with a loss margin of more than 40% for the trailing 12-months. The company’s debt level stands at more than $24 billion compared to a cash position of just over $3.4 billion.
Caesars operating margin of 10.62% illustrates how the huge debt is affecting its ability to convert operating income into profits. Additionally, its top line growth rate of 3.1% in Q2 implicates that it might take time for the company to resume its profitability given its massive loss margin and debt on its books.
Caesars will discuss Q3 2014 results on November 10 and investors will be watching to see if there is any improvement on the bottom line as well as its current debt position. Perry Corp, one of the largest creditors to Caesars walked away from debt restructuring talks that would have seen the Resorts and Casinos Company reorganize its debt position.
According to analyst estimates, Caesars Entertainment is expected to remain unprofitable for the next few quarters, through 2015, and some are actually suggesting that the company could soon file for bankruptcy.
Contrary to Caesars Entertainment, Las Vegas Sands looks like a much healthier company from a financial standpoint. The company enjoys significant profitability margins with an operating margin of 26.78% and a net profit margin of 18.19%.
Its valuation multiples are also better as it trades at a trailing 12-month P/E of 18.85x as compared to the industry average 23x. This also compares to P/Es of close rivals, Wynn Resorts and MGM Resorts, which trade at 23.04x and 78.40x respectively. Therefore, from a valuation standpoint, both Wynn Resorts and MGM Resorts appear a little bit expensive compared to Las Vegas Sands.
Las Vegas Sands generates a significant level of free cash flows (FCF) compared to its rivals. Reports indicate that the company FCF generation stands at about $3.775 billion for the trailing 12-months, as compared to MGM Resorts’ $695 million and Wynn’s $611 million. Melco Crown Entertainment (NASDAQ:MPEL) is the closest rival in this respect, but only managed $1.496 billion.
The company has an outstanding debt of $11 billion, which shows that despite its ability to generate incredible amount of free cash flow, it also has a high burden that it needs to service. This could put the profitability margins under pressure, thereby affecting the company’s ability to continue generating high levels of free cash flows.
The same scenario is reflected on the books of MGM Resorts with an outstanding debt of $12.92 billion. Given MGM’s total cash of $1.31 billion, the company might have to rely heavily on operating cash flows to service its debt. This will continue to affect the company’s ability to increase the level of free cash flows.
On the other hand, Wynn Resorts has $7.31 billion worth of debt outstanding on its books and based on its current trailing 12-month free cash flows as referenced earlier, this could turn out to be a problem for the company in the near future.
Generally, all these companies have high levels of debt. While theirs is nowhere close to what Caesars Entertainment has on its books, there is clear indication that if not managed well, the debt could continue soaring thereby pushing the companies to financial positions that could make investors shy away from these stocks.
Caesars Entertainment may be planning for alternatives after plans to reorganize its debt position fell through after Perry withdrew from talks. This could be a huge signal of just how investors are growing cautious over investment in the Resorts and Casinos industry. The other major players, including MGM, Wynn, and MPEL seem to struggling to keep up with LVS in term of free cash flow generation, but their debt positions are no better and could get worse if profitability margins continue to suffer from high interest servicing.
The bottom line is that with these massive amounts of debt, the companies’ current valuation metrics could become under pressure as investors look to cash out before a major plunge.
Disclosure: No positions