Odds Stacked in Casino Stocks' Favor

You've read the headlines. Las Vegas is dead. Casinos in that city and other parts of the U.S. are facing some of the worst slumps in their history.

But if you think today is a bad time to invest in casino stocks, you're wrong, says one veteran investor in the sector.

"Now is one of the best buying opportunities ever for casino stocks," says Larry Haverty, associate portfolio manager with Gabelli Global Multimedia Trust ( GGT), a closed-end fund that has more than 13% of its holdings invested in the casino industry.

Specifically, today rates as the third-best buying opportunity in recent history -- behind the 1987 stock market crash and the 1991 start of the Gulf War, he says.

Haverty says there are numerous positive catalysts for the sector over the next six months, including falling oil prices and his bet that MGM Mirage ( MGM) and Las Vegas Sands ( LVS) will secure additional financing for their multibillion-dollar casino developments under way in Las Vegas and Asia.

Haverty's fund is down about 28% this year. Casino stocks have been dismal performers, as business is down in Las Vegas and other parts of the U.S., while competition in Macau is hurting margins.

Nonetheless, Haverty's dedication to the sector has not faded.

A simple reason to like the industry, he says: Most of the customers are addicted one way or another, and the government limits supply. "Those are good combinations. As the owner of the business, eventually you make money from those things," he says.

Haverty's fund is part of GAMCO Investors ( GBL), which is run by Mario Gabelli -- a legendary value investor who's a proponent of the Graham & Dodd school of fundamental stock analysis. Warren Buffett is another fan of this school.

Casinos and Oil: An Inverse Connection

Haverty says a big reason for the casino sector's decline over the past year has been due to the surging price of oil. He sees parallels to the start of the first Gulf War in 1991, when investors worried that there would be gas shortages.

"Most of the historic bottoms in the casino stocks have coincided with historic peaks with energy bubbles," Haverty says. "The stocks trade inverse to energy."

This year, the S&P Crude Oil ETF ( OIL) is up about 30%, while shares of casino bellwether MGM Mirage are down 63%.

Already, the rising price of gas has hurt MGM and other Las Vegas operators, which rely on drivers from California for a good piece of their business. Now airlines have begun cutting back on flights to the city, because of steep jet fuel prices.

Haverty says air travel to Vegas will temporarily decline about 10% this fall, which could end up resulting in 25% to 30% year-over-year declines in cash flows at casino companies. Already, in the first quarter, MGM said its Las Vegas property EBITDA (a proxy for cash flow) was down 13% from last year.

However, once airlines stop using as much oil, he says, oil prices will drop. Indeed, we're already seeing those effects. Crude oil has fallen below $120 per barrel this week, down from a peak that was above $147 in July.

When airlines remove the temporary flight cutbacks to Vegas, then the cash flows at casino stocks could rebound quickly, Haverty says.

The Debt Factor

Two other positive catalysts in store for the casino sector revolve around the debt markets. The sector's selloff this year has been partly due to worries that casinos would not find attractive financing for their development projects, which would hurt growth expectations.

Last week, Boyd Gaming ( BYD) said it was delaying its massive Echelon Place development in Vegas because of the difficult debt markets.

Next in line for financing are MGM Mirage, which needs about $3 billion more in funds to complete its City Center development on the Vegas Strip.

Likewise, Las Vegas Sands still needs to secure additional financing for its casino developments in Singapore and in Macau.

Haverty expects both firms to secure financing -- which he says would provide catalysts for the entire casino sector.

What makes him so optimistic? He points to Gaylord Entertainment ( GET), a lodging company his fund owns that has a hefty debt load but nonetheless received a $1 billion credit line from Bank of America, a major lender to casino owners.

None of Gaylord's properties had casinos attached to them, and casino income is often considered to be a stabilizing force for a hotel's cash flows.

"It's better to lend money to a hotel with slot machines than one without," he says.

But not everyone agrees with this thesis. "Lodging is more cyclical than gaming. Nonetheless it is more of a well-established asset class among lenders than gaming," says one private equity official, who previously worked in real estate investment banking.

This source says MGM's City Center may turn out to be a very profitable property, but the speculative nature of the project and the dismal current gaming fundamentals in Vegas make it difficult for banks to commit further capital to the development.

A Question of Valuation

While Haverty admits casino stocks could get cheaper, he says they are already trading at very reasonable valuations. "These are first-class real estate entities. There always seems to be value for first-class real estate entities," he says.

Haverty's fund owns many of the casino stocks today, but he thinks the best opportunities are in MGM, Wynn ( WYNN), Penn National ( PENN) and Pinnacle ( PNK).

But what about all the Wall Street analysts who have lowered price targets on most of the casino stocks over the past year, as they argued the companies should trade at lower earnings multiples?

When asked about this, Haverty points to one of his favorite sayings: "You can't break your neck falling out of the basement." In short, the stock valuations have fallen to very low levels.

Of the Wall Street sell-side analysts covering the stocks, he doesn't think any of them were covering the sector back in 1987 and 1991 -- which were the last great buying opportunities he witnessed.

Back then, the casino stocks fell about 70% to 80%, similar to the bludgeoning of this past year, he says. They eventually rebounded sharply.

He expects a V-shaped correction to play out again this time around. Over the next two years, casino stocks will double, Haverty predicts.

In times like these, fear is driving the sector to unreasonable levels. "The stocks go down far worse than the business does," he says.

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