Will Casino Stocks Crap Out in 2013?

NEW YORK (TheStreet) -- I am a sucker for gaming stocks. I admit it; I simply like the idea of owning a piece of "the house."

It isn't the glamour and neon lights that I find very captivating (well maybe a little); it's the complete flexibility in customer service methods I find key. Each customer represents so much profit, casinos are able to go well beyond what almost every other business can spend.

The mountains of cash are entrancing for customers and shareholders. Between the choice of the customer or house, unequivocally I'll take the house every time.

Furthermore, casinos offer another advantage over many other industries; it's relatively easy to know how well a casino is performing. Due diligence is not a lot more difficult than slipping on tennis shoes and taking notes as you walk around.

Total due diligence is much more than walking around and observing the casino floor; however, if you walk the floors of enough casinos enough times, you have an opportunity to stay ahead of the curve.

For some companies though, including MGM Mirage ( MGM), Wynn Resorts ( WYNN) and Las Vegas Sands ( LVS), a simple walking tour may require a trip to Asia.

The Energy Wheel

It may at first glance appear unrelated, but natural gas will increasingly influence the gaming industry's earnings. Natural gas prices are so low that transportation is migrating from gasoline and diesel toward natural gas as a fuel source.

UNG Chart UNG data by YCharts

Natural gas is represented by United States Natural Gas ETF ( UNG); if your car was powered with natural gas instead of gasoline, the cost for fuel would feel like $2.25 a gallon.

A significant bonus with using natural gas is the production is domestic for the most part. The result is a significant reduction in imports and an improvement in our balance of trade.

Fuel prices drive the economy and the economy drives the profitability of U.S.-based casinos. Low natural gas prices equate to an increase in the total amount of disposable income. UNG currently trades near $21 and as long as it remains under $35, consider it bullish for the U.S. economy.

Another significant influence for disposable income is taxation. Taxes are expected to increase significantly in 2013 and again in 2014. (Read my article titled 5 Oversold Stocks Ready for a Bounce Higher.)

The 2014 increase will not appear the same as an outright tax, as it is largely hidden inside of payroll, but the impact will be the same. In 2014, the requirement for employer-provided "approved" health care, and increased costs of labor will result in fewer people employed and lower paychecks for many.

For example, if employers are required to provide a $2 per hour benefit, it's obvious businesses will adjust the cash compensation to equalize the value of the employee.

Smaller paychecks are the most direct method of lowering disposable income I know. Fortunately, many gaming companies have exposure outside of the U.S. and will continue to grow. The three gaming stocks to play with exposure outside the U.S. are Las Vegas Sands, MGM Mirage and Wynn Resorts.

All three have exposure to Macau, but the three are very different in terms of performance domestically and internationally. The Sands also has a location in Singapore that unsurprisingly is nearly a printing press for money. The Sands Singapore location is more important than the profits it generates. The Singapore location is built in a place that has a high respect for the rule of law and by definition gives The Sands increased diversification.

Royal Caribbean Cruises ( RCL) and Carnival ( CCL) are technically international gaming companies, but since the lion's share of their revenue comes from the U.S., they really are defacto domestic casinos.

I haven't taken a trip on Carnival, but I have sailed on Royal Caribbean more than once. I watched and reviewed and was amazed at how poorly Royal Caribbean monetizes their casinos. My sample size is very small (two trips), but they were consistent with each other.

As a result of poor casino management and relative costs of operations, I can't endorse either Carnival or Royal Caribbean as a gaming investment idea.

BYD Chart BYD data by YCharts

Another large domestic gaming operation is Boyd Gaming ( BYD). Boyd does have a small Las Vegas Strip location that if I am kind I will describe as vintage. Otherwise, Boyd depends on locals and the budget demographic player. This is the type of player I believe will lose the most in disposable income as we approach and move past 2014. On a relative basis, someone earning $20 an hour who experiences a pay cut to $18 an hour to pay for health care will have less disposable income than someone earning $40 an hour and already receiving acceptable or nearly acceptable health care coverage.

BYD Debt to Equity Ratio Chart BYD Debt to Equity Ratio data by YCharts

Without changes to the health care mandate on businesses (really on employees), anticipate Boyd shares to get hit hard. Business in Las Vegas has picked up on the strip, but the local market is still in the crapper. One more major catalyst holding down employment and wages is the last thing Boyd needs.

Again, keep an eye on UNG and news of migration from gasoline and diesel. Lower energy prices provide a quick and significant boost to many wallets.

WYNN Chart WYNN data by YCharts

Wynn is well run, and no one knows Vegas better than Steve Wynn. Wynn also has operations in Macau with more in the works.

Finding staff is an issue for Macau (not in Vegas), but staffing should not turn into a material problem. China taxes the casinos at such a high level that they don't want to turn the money faucet down any more than the casinos.

Wynn has a history of paying fat dividends. Unfortunately, taxes on dividends starting in 2013 are going either higher or really higher depending on your tax bracket. We will have to wait to see what impact the higher tax rates will have on the amount of dividends, but it's safe to say betting on sizable increases may turn into a long shot.

MGM Mirage

MGM Chart MGM data by YCharts

MGM is weighted down from a titanic debt load, only this titanic doesn't appear to sink as quickly. At some point, MGM is a buy, but that point is not here yet. MGM has a lot of rooms to fill and 2013 is just around the corner.

MGM Debt to Equity Ratio Chart MGM Debt to Equity Ratio data by YCharts

If Washington comes together and taxes remain at current levels I would add shares to a portfolio. However, the odds are in the same ball park as me winning the World Series of Poker this year.


CZR Chart CZR data by YCharts

Caesars Entertainment ( CZR) is a well-run operation, but the stock has a few issues to note. One is the size of the float relative to the total shares. The float is only about 20% of the total shares, and profits have been elusive for management.

The second issue with Caesars is they are controlled by a large fund. This is a double-edged sword. While having a say in the company isn't likely to happen soon, the smartest guys in the room are probably from the fund.

Las Vegas Sands

Las Vegas Sands remains my top pick at this time. The combination of U.S., China, and Singapore casinos instills resilience for economic downturns. Interest expense for the rather large debt load continues falling, and there is plenty of time to secure renewed financing as debt comes due. TheStreet'sTimothy Collins recently wrote about LVS volatility Keep an Eye on Volatility. (You need a Real Money Pro account to read it, but Collins' analysis alone makes it worthwhile.)

LVS Chart LVS data by YCharts

No need to hurry or rush to the tables though. The current chart pattern is a bearish trend and $30 is the next major support area. I don't expect $30, but $35 is not off the table. September $34 strike put options are attractive at $1 per contract this week. (Read my article Can 'Big Coal' Dig Out of its Hole?.)

LVS Debt to Equity Ratio Chart LVS Debt to Equity Ratio data by YCharts

If LVS does continue falling and an option writer was exercised, the cost basis for shares is only $33. Selling puts mitigates risk, pays you for your time and if The Sands doesn't fall enough to get exercised the return is 3% for a holding period of 60 days.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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