The gambling sector seems to have finally drawn a better hand, as consumers in both the U.S. and Asia are feeling a bit more flush in the first half of 2013 and willing to travel to their favorite casinos. As ValueLine analyst Dominic B. Silva sums it up: "The hotel/gaming industry is highly dependent on the business cycle and consumer discretionary spending; operating earnings can swing widely between good times and bad." Another positive for the industry is that people in many states don't have to venture as far to gamble as they once did, since several U.S. states such as Pennsylvania and Ohio have legalized gambling. Casino ballot initiatives and openings are also occurring in other states including Ohio, Oregon, Arkansas, Massachusetts, Rhode Island and Maryland. New gambling developments in Asia's such as Macau and Singapore are also boosting industry revenues and profits.
To describe the catalysts that are boosting gambling companies' revenues and profits, analyst Esther Y. Kwon of S&P Capital IQ wrote that, "In our view, the legalization or development of new U.S. gaming markets has accelerated with the debut of gaming facilities in states such as Ohio, and state budgetary shortfalls. Casino gambling is now legal in more than 20 states, and we see a trend toward gaming machines being increasingly allowed at U.S. racetracks and other venues."
In fact, the three largest U.S. casino-resort operators, Las Vegas Sands (NYSE: LVS), MGM Resorts International (NYSE: MGM) and Caesars Entertainment (NASDAQ: CZR) reported improved first- and second-quarter financial results, mainly due to rising demand in Macau. For example, Las Vegas Sands' net income rose 134% compared to the same-year ago period, to $672 million, largely buoyed by the three phases of its Sands Cotai Central project that have opened in Macau since last April. The project generated $584 million in second-quarter revenue. The strong results in Asia offset the effects of lower profit from the company's Las Vegas properties - a 6.8% increase in revenue per available room (RevPAR) was more than wiped out by lower table-gaming winnings. Revenue rose 25.6% to $3.24 billion.
MGM Resorts International, which last year overtook Caesars Entertainment as the No. 2 U.S. casino-resort operator to Las Vegas Sands, posted a net loss of $93 million, compared with a $145.5 million loss a year earlier, when the company took certain one-time charges. Revenue rose 7%, to $2.48 billion. Caesars, which, of the three, was the most impacted by last year's Superstorm Sandy because of its Atlantic City holdings, narrowed its second-quarter loss by 13% from a year earlier, to $209.2 million.
With industry revenues and profits on the road to recovery, it may be interesting to examine investing opportunities among smaller industry players such as Century Casino (NASDAQ: CNTY), Bally Technologies Inc. (NYSE: BYI), a global gaming supplier that recently acquired SHFL entertainment, Inc. (NASDAQ: SHFL), and Kinbasha Gaming International, Inc. (OTCQX: KNBA), owner and operator of retail pachinko gaming centers in Japan.
Century Casino (NASDAQ: CNTY)
Century Casinos Inc. is an international casino entertainment company that owns and operates Century Casino & Hotels in Cripple Creek and Central City, Colorado, and in Edmonton, Alberta, Canada and the Century Casino in Calgary, Alberta, Canada. The Company also operates casinos aboard twelve luxury cruise vessels through its Austrian subsidiary, Century Casinos Europe GmbH., the company holds a 66.6% ownership interest in Casinos Poland Ltd., the owner and operator of nine casinos in Poland. Century also manages the operations of the casino at the Radisson Aruba Resort, Casino & Spa in Aruba, Caribbean.
Just as the second-quarter results for the largest gambling stocks were robust, Century Casinos reported quarterly earnings of 15 cents a share. Overall second-quarter results were strong: net operating revenue was $28.3 million, a 59.3% increase compared to same year ago period; and net earnings were $3.7 million, a 218.6% increase. For the quarter, about $26.1 million of revenue, or 86%, was from gambling and close to $3.2 million was from hotel, bowling, food and beverage and other.
S&P analyst Kwon states in her report that "since May 2013, the technical indicators for Century have been bullish." Century's stock price, now at $5.13, may be undervalued compared to the casinos and gambling industry and trading at a significant discount based on both trailing P/E and forward PEG, according to Morningstar. Its PEG ratio stands at 0.5x - the lowest among other casino players - while its P/E of 16.1x is below the 17.2x S&P 500 average and its own 18.2x 5-year average.
Another positive is that the $123 million-in-market cap company has nearly $25 million in cash on the balance sheet and relatively low long-term debt. The company is now pursuing a project in Asia, which is positive because "since early 2008, the center of the global casinos and online gambling industry has progressively moved from Las Vegas and Atlantic City to Macau in China," according to IBISWorld industry analyst Craig Shulman. He predicts that this shift of the industry's activities to Asia will continue with casino development in Macau and Singapore.
Bally Technologies Inc. (NYSE: BYI)
Bally Technologies Inc. is a global gaming supplier that recently acquired SHFL entertainment Inc. earlier in July, which could provide it with a strong catalyst moving forward. SHFL entertainment Inc. manufactures automatic card shuffling equipment, table games and video slot machines for casino operators. The organization has a dominant 90% share of the shuffler business and 80% share of the proprietary table game market. Shuffle Master owns some of the industry's most played table games such as Pai Gow Poker, Let It Ride, and Texas Hold'em.
The Asia angle was also an important part of the story for SHFL's strong results for its second quarter ended April 30, 2013. CEO Gavin Isaacs stated that "Our record second quarter results reflect a continuation of the strong worldwide demand for our innovative products, particularly in Australia and Asia." The company's MD3 card shuffler helped fuel the quarter's growth with record placements of 520 units, its strongest performance to date. The company's slot machine, shuffler, and specialty table games businesses continued to gain momentum, with each segment reporting record revenues in the quarter. Total revenue grew to a record $77.4 million, a 17% increase from the prior year period, while net income increased 22% year-over-year to a record $11.8 million during the first quarter before its acquisition.
The company had a strong balance sheet with cash of $34 million with little long-term debt. Additionally, the company is free cash flow positive, which may leave room for a possible dividend in the future. Although SHFL entertainment Inc. is headquartered in the United States, it derives most of its sales outside of its home market: sales in the United States were $114.66 million which was only 44.3% of 2012's sales, according to Wright Investors' Service. In 2012, sales in Asia rose at a rate that was much higher than the company as a whole: in this region, sales increased 37.8% to $28.13 million.
Bally Technologies Inc. may have paid a 70% premium by acquiring SHFL entertainment Inc. for 4.6x its annual revenues and 33x annual earnings, compared to its own 2.7x annual revenues and 19x annual earnings ratio. Shareholders have forgiven this premium due to estimated synergies of at least $30 million and incremental earnings that could bring multiples down to 22x earnings. In fact, Bally's shares rose about 7% after the deal was announced as shareholders applauded it. The stock may be worth a second look for investors, particularly after a retracement from its highs.
Kinbasha Gaming International, Inc. (OTCQX: KNBA)
Kinbasha Gaming International Inc. is an owner and operator of retail pachinko gaming centers in Japan. It operates 21 pachinko parlors in the Japanese prefectures of Ibaraki, Tokyo and Chiba. For more than 50 years, the company's retail gaming establishments have offered customers the opportunity to play the games of chance known as pachinko and pachislo. Kinbasha, the only Japanese gaming security currently traded publicly in the U.S., may be an attractive position for those seeking to benefit from its plans to capitalize on Japanese market dynamics, reinforce a leadership position and build a national gaming franchise in this rapidly consolidating industry.
As in the U.S., gaming in Japan is enormous - the industry generates over $200 billion in gross wagers annually. Unlike the U.S., however, where the business is generally clustered in gambling-focused markets such as Las Vegas and Atlantic City, Japanese gaming centers are located throughout the country, with small chains and single-location operators accounting for a considerable proportion of facilities. These gaming locations, known as pachinko parlors, allow players to play pachinko, which is played on a device that resembles a vertical pinball machine.
Pachinko is the country's leading leisure industry, which may account for the nearly quarter of a trillion dollars in wagers in 2012, according to Tokyo's Ichiyoshi Research institute. The Wall Street Journal has taken notice, as well, reporting in July 2012 that the pachinko market is five times the size of the Las Vegas gambling industry.
Japanese gamblers also play pachislo, which resembles a western style slot machine at pachinko parlors. In fact, Japan is the world's largest market for slot machines, with 1.4 million slot machines compared to 853,000 in the U.S.
From a quantitative perspective, Kinbasha offers investors value through a surprisingly low price-sales multiple - the company is currently valued at 0.12X annualized revenue of more than $90 million, while the U.S. gaming industry is valued at roughly 2.2X, according to recent Morningstar valuation data.
However it's not a perfect story. Kinbasha has a sizable amount of debt on its books, and a large percentage of this is considered in default according to US-GAAP. During the year the Company was able to reduce its total debt from $159.8 million at March 31, 2012 to $132.3 million as of March 31, 2013. Total debt was then further reduced in its most recently reported quarterly results to $122.5 million as of June 30, 2013. These are sizable figures, however it is important to note that in Japanese culture, companies typically carry much larger debt loads than in the United States and the Japanese government encourages lenders to work with companies in this regard.
For the past several years, Kinbasha has negotiated with its lenders and in many cases has obtained formal or informal forbearances and loan modifications that have allowed it to effectively extend the maturity of its debt through interest only and/or reduced principal payments. For example, in March 2013, the Company announced it had restructured a loan in the amount of $6 million, resulting in a $5.2 million gain.
As it restructures its debt the company is putting a major focus on high density areas such as Tokyo. The company made a decision to introduce lower denomination slot machines at two of its parlors in the Tokyo metropolitan area. Gross wagers at the company's locations in Shinjuku and Fuchu have increased due to the fact that customers have the opportunity to play slots using 5 yen tokens, as opposed to standard 20 yen machines.
Luckily for long term value investors, Kinbasha is completely under the radar. The company recently reported impressive financial results that went largely unnoticed. For the fiscal year ended March 31, 2013, net revenues increased to $93.9 million for the year ended March 31, 2013 from $91.2 million in the year ended March 31, 2012.
Likewise, net income improved to $11.6 million for the year ended March 31, 2013 as compared to a net loss of $6.1 million in the same period of 2012. As a result, fully diluted EPS improved to a sizable $0.95 in fiscal 2013, compared to a loss of per share of $0.82 in fiscal 2012. Although part of Kinbasha's fiscal 2013 net income was due to a $5.2 million gain on forgiveness of debt, Kinbasha has continued to show improvements to the bottom line, recently reporting $761,000 in fiscal first quarter results, compared to a net loss in the same period last year.
With KNBA trading at $0.75, a reported EPS of $0.95 in its most recent fiscal year is quite a discrepancy. Despite its debt load, these numbers are striking for any value investor looking for an undiscovered company with an attractive PE ratio and nearly $100 million in annual revenues.
About Emerging Growth LLC
EGC is a marketing and consulting firm that specializes in creating ongoing communications strategies for public and private companies.
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