Annual Model Portfolio


2012 Portfolio
Last year we warned that gaming stocks were
entering the year with too high of a valuation. This year, we
are saying the opposite. Regional gaming stocks are the most out
of favor we have ever seen them, mainly because there
is little faith that the US government will be able to fix what
many feel is impacting current performance -unemployment, low
interest rates (retirees) and weak consumer confidence. While
this definitely impacts the regional
casinos, we believe the low valuations reflect the current and
coming competition as all investors shouldbe concerned about the
way the opening of The Rivers impacted casinos in three states
and gauge the upcoming openings of new casinos to see if there
will be any more situations like this.
Offsetting all the concerns are very low
valuations on companies like Penn National Gaming and Pinnacle
Entertainment, a distinct lack of interest in Isle of Capri
Casinos, and a question of how to value companies like Boyd
Gaming and Ameristar Casinos. Retail investors have completely
abandoned the microcap names like Full House Resorts, Nevada
Gold & Casinos and Lakes Entertainment as the hedge funds
don’t even want to look at a stock that isn’t trading at
least 200,000 shares a day.
While Macau and Singapore’s gaming markets
continue to outperform, the media, Asian gaming analysts and
investors are acting like they are sure the punch bowl has been
taken away and that this cannot be sustained. We absolutely
agree that Macau gaming revenue cannot keep rising at 40% for
the 3 rd year
or that both Singapore casinos cannot double what revenue
expectations were but so what? Trees do not grow to the sky and
EBITDA growth is more important than giving away the store so
top line revenue looks good. Last year we told you that for
Macau growth to continue we would need to see visitation metrics
picking up after the opening of Galaxy Macau. We felt double
digit visitation growth was what was needed to generate 22
billion patacas a month in gaming revenue with more high margin
business coming to Macau from the mass market. Galaxy Macau was
initially a complete disappointment as a mass market attraction
but the visitation and gaming revenue growth metrics we were
looking for were achieved despite Galaxy’s failure. In 2012
Sands China/LVS’ Cotai Central will open and while SCL/LVS are
well on their way to being the biggest market share and revenue
gainer of the group in the coming year, investors do not seem to
want to give them credit for this, at least not yet.
Las Vegas has moved from hope for a recovery, to
the recovery is underway and is entering 2012 with the reality
that we are recovered and now we need to maintain this momentum.
With only Caesars Entertainment adding hotel capacity in 2012,
we should remain strong in the first half of the year while the
second half will have tougher comparisons and uncertainty as we
head into the Presidential Election.
We are entering 2012 with the highest levels of
global uncertainty and that has paralyzed economies and
financial markets since early summer. This type of environment
is one where investors should seek safety in cash rich, cash
producing companies. With so much uncertainty over the economy
and income tax situation, we believe more companies will begin
to distribute more of this cash ahead of a potential increase in
dividend tax rates, at least in companies with high insider
ownership.
We believe there are three ways to categorize
gaming stocks for the coming year. The first is growth and that
is the smallest part of the group given the lack of clear
identifiable opportunities currently. The second is cash
rich/cash flow and the third is just plain low valuation.
Obviously given the year we just had the last category is quite
populated.
We continue to believe that the best growth
opportunities are in Asia and other international markets and
that the US market is saturated. Given the budget issues and
economic situation more and more states are looking to find ways
to raise capital and gaming will continue to be looked at as a
golden goose with ignorant politicians looking at statistics
from 10 years ago and opponents continuing to find ways to delay
or stop expansion in its tracks. The Northeastern portion of the
US is the most saturated but the opening of the Rivers in
Illinois shows that expansion in the Midwest makes little sense.
While a handful of states will pass casino legislation or
expansion, despite the obvious, we also feel more states will
consider a quicker fix by allowing VLTs or slot routes.
All this sounds like a great environment for
suppliers and it is but this outlook has been here for a couple
of years but regulatory and political delays have coupled with a
continued sluggish replacement cycle to keep investors on the
sidelines. We believe that by the second half of calendar 2012,
investors will react to better visibility by slot companies
regarding VLT installations in Canada, Illinois, Italy and Ohio
along with the timeline for openings of casinos in Ohio, Kansas,
Missouri, Massachusetts, Atlantic City and Pennsylvania. As for
Internet gaming, unless Caesars Entertainment is successful with
its IPO, it will continue to be a big distraction for casino
companies and a long term opportunity, but short term waste of
time and effort for most of the suppliers.
In 2011 it was very difficult to stick with
fundamentals as a reason to invest given a very emotional and
erratic global stock market. It has become clear that the
activity in Asia, mainly Macau given the news flow, dominates
the actions of gaming stock investors in the United States.
Making that situation even more dangerous is that Hong Kong
investors determine the valuations and trends in the stock
prices of the US Macau subsidiaries and to put it politely, they
are completely clueless about the gaming industry. Last year we
reminded you to take what you hear out of Asia with a grain of
salt and to use common sense when accessing the news and
volatility it creates. Even though the perception of Macau and
actions of Hong Kong gaming investors and analysts were a good
part of the reasoning behind where gaming stocks ended the year,
we remind everyone that this works both ways and that around the
time of the opening of Galaxy Macau and the MGM China IPO,
gaming stocks were valued at their highs because of the
extremely high, and unsustainable, valuations that Hong Kong
investors had assigned the group. Being able to identify when
the imbalances occur, both high and low, will be even more
important going forward.
Good Luck and Profitable Investing!!
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