Casino Stocks Riding High

Casino stocks are near 52-week highs and research reveals that institutional investors are buying the highfliers as Wall Street analysts raise earnings estimates, saying the revenue recovery will only get stronger. But valuations are getting pricey, forcing investors to be a bit more selective about the group.

Bullishness on casino stocks, however, continues to be the prevailing mood. J.P. Morgan analyst Harry Curtis boosted his earnings estimates on Caesars Entertainment ( CZR) and MGM Mirage ( MGG) Thursday, telling investors that first-quarter results are ahead of expectations. In Curtis' view, Las Vegas results will drive gains in revenue per available room, a key lodging metric known as Revpar.

"Our revised estimate assumes 8% to 9% EBITDA growth in Las Vegas year over year vs. our previous expectations of 2% to 3% growth," said Curtis, noting that fourth-quarter Revpar grew by 7%. "Our call-in surveys suggest 15% rate growth in call-in rates, which we estimate will result in 10% to 11% Revpar growth."

And while Curtis didn't up his estimates for the fiscal year, he said that 2004 results could see some upside, with signs of exceptional Revpar growth seen in the second quarter as well. Based on current call-in surveys of room rates in April and May, Curtis said that Caesars could see Revpar grow by 1% to 2%, while MGM could see Revpar gains as well.

Any Revpar gains would drive earnings estimates higher for both casinos. Curtis estimates that a $3 to $4 hike in average room rates at Caesars would add a penny to earnings per share per quarter, while a $1 increase at MGM would add a penny to EPS.

The revenue recovery has not only lifted results at the largest casino operators, it's also enabled smaller, regional casinos to clean up their balance sheets. In the last few weeks, Argosy Gaming ( AGY), Ameristar Casinos ( ASCA) and Isle of Capri Casinos ( ISLE) have all refinanced their high price debt at lower rates, which is immediately accretive to earnings, and prompted Deutsche Bank to raise 2004 estimates and price targets.

"We think that this will be very important to the long-term capital structures and balance sheets of these companies," said Marc Falcone, gaming analyst at Deutsche Bank.

As a result of the rising Revpar gains, nearly every casino name in the Dow Jones Casino Index is at or near a 52-week high. But even as earnings estimates climb, share prices are moving in lockstep, which makes some of these companies appear pricey, depending on the valuation metric used.

On a price-to-earnings basis, the Dow Jones Casino Index currently trades at 26 times 2004 earnings expectations, which is at the high end of its five-year average P/E range between 29 and 9 times future earnings, according to Baseline. And on a price-to-cash-flow basis, the Dow Jones Casino Index appears overvalued, trading at 17.2 times cash flow double its five-year historical average of 8.5, according to Baseline.

But Wall Street analysts value casinos using earnings before interest, taxation, depreciation and amortization because they own land and other assets. On this basis, casinos don't seem as expensive, with the large-cap operators trading between 8 and 9 times 2004 EBITDA, in line with the long-term average, according to Smith Barney research.

And through the fourth quarter, recent research from Susquehanna Financial Group shows that institutional investors were continuing to invest in the sector. According to a report from analyst Eric Hausler, institutions managing $100 million in assets increased their net positions by $236 million, resisting the urge to take profits in a sector that performed well.

"It's telling that very few institutions reduced their position in gaming to zero," said Hausler. Even investors who cashed out left some money on the table, because they believe there is still more upside in the sector."

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