Casino stocks took a pounding Wednesday after MGM Mirage's ( MGM) quarterly report failed to provide the inspiration necessary to sustain the past week's mini-rally. The sharp selloff reflected just how negative investor psychology has become in the gambling sector over the past three months. The shift began when many casino companies' second-quarter results failed to match the blowout performance of previous quarters. It accelerated on concerns about a slowdown in Las Vegas' recent hot growth, the impact of higher energy costs and interest rates on consumer spending and the damage to Gulf Coast gaming markets from recent hurricanes. Investors seemed to have briefly set aside that negativity over the past week, bidding up casino stocks after analysts at Wachovia and Deutsche Securities upgraded shares of Boyd Gaming ( BYD). But for the recent rally to have legs, investors would have needed a strong third quarter or exciting guidance from one of the big Las Vegas companies, and MGM Mirage's report failed to impress. "It's going to be tough for the Street to spin these results to the positive, and it's unlikely any 'relative valuation' calls such as Wachovia on Boyd are going to lift the space," says Steven Gart, a gaming analyst at Langner & Co., a San Francisco-based equity research firm. "The estimates just feel toppy now. On top of that, MGM's share price had held up the best in the space over the last quarter." Gart doesn't own any shares of gaming companies and his company doesn't do investment banking. MGM Mirage's stock fell hard Wednesday, losing $5.46, or 12.5%, to $38.25. Just about every public gaming stock fell in sympathy, and the Dow Jones U.S. Gambling Index was down 4.3%. Some Wall Street analysts did say MGM Mirage's results show its Las Vegas business remains solid. However, the company's forecast for 6% fourth-quarter growth in revenue per available room on the Las Vegas Strip, down from third-quarter growth of 9%, played right into investor jitters about slowing growth in Sin City. During a conference call, MGM Mirage executives offered a preliminary forecast for Revpar percentage growth in the midsingle digits next year.
Goldman Sachs analyst Steven Kent noted that MGM Mirage's Revpar growth in the fourth quarter of 2004 was 13%, making for a tough comparison in the current quarter. But he added that "guidance is clearly a deceleration from the 9% increase in the third quarter and will fuel investors' fears that trends are finally slowing after the torrid pace of the past few years." Goldman Sachs does and seeks to do business with companies covered in its research reports. Jim Murren, MGM Mirage's president and CFO, said in an interview that the focus on Revpar may obscure the company's real prospects. He notes that because of new hotel construction, MGM Mirage has 120,000 more room nights to sell in the current quarter than it did a year ago. Combined with the expected Revpar increase, that will translate into "very strong" overall revenue growth in the fourth quarter. "What is relevant is how much money are you making," Murren said. "When you have more rooms to rent, new casino space, new restaurants and bars, you should make some more money." The executive also said that while it's hard to predict leisure trends for next year -- because many individual visitors to Vegas plan their trips close to their departure -- the convention and conference business looks "pretty strong" in 2006. Murren also quibbled with initial disappointment with the company's third-quarter margins, noting the year-ago period benefited from an unusual gain related to bad-debt provisions. The provisions returned to a normal level in the latest quarter, and Murren said that excluding last year's unusual gain, margins would have improved year over year. The sector's real problem may lie in the habit investors and analysts fell into when casino operators were reporting quarter after quarter of results that trounced Wall Street estimates, accompanied by unequivocally bullish guidance. Analysts would be able to raise estimates, and investors would then bid up shares to lofty valuations. Those valuations proved too high to maintain when companies started reporting second-quarter results that were merely in-line or a touch better than estimates. "It appears we are at the crossroads where analysts cannot lift estimates near-term and this makes the gaming space less momentum-driven and more about fundamentals and valuation," Gart says.