Gaming stocks may fall further

How low can they go?

Stocks of companies with Las Vegas gaming ties have performed abysmally over the past two years, dropping in value nearly 41 percent, or $18.6 billion, from peak levels.

The GAX index of 14 gaming stocks is down 28.3 percent from its high this year alone, more than double the losses posted by the Dow Industrial, S&P 500 and Nasdaq Composite indices.

Fueled largely by Wall Street's belief there are too many gambling halls and not enough gamblers, the rout has affected both big Strip casino companies catering to the tourist market and smaller operators of neighborhood casinos.

And even with prices of casino stocks at historic low levels, analysts say it's likely they'll fall even further -- perhaps another 10 to 15 percent -- before staging a comeback.

The reasons for the pessimism include gaming companies' rising debt levels and declining cash-flow margins, Asia's economic woes and the across-the-board drop in U.S. stock indices as profit growth slows.

Of the latter, says Bear Stearns & Co. analyst Jason Ader, "A lot of people are calling this the end of the bull market. There are a lot more sellers than buyers out there."

Still, there are some encouraging signs for gaming-stock investors who zero in on the right companies.

On a macro level, consumer spending remains strong despite declines in portfolio values. This bodes well for newer, full-service gaming and entertainment resorts competing for the discretionary spending dollars of their primary targets -- the 73 million Baby Boomers looking for places to spend their wealth, which will increase with a rebound in the overall stock market.

And record amounts of money are flowing into mutual funds, which have to find some place to invest that cash. With inflation low and government bond yields in the 5 to 6 percent range, fund managers are looking to equities, which have traditionally posted higher returns.

Those low debt yields also make it cheaper for companies that generate predictable cash flows and boast strong balance sheets to borrow money for expansion. That, coupled with low energy costs, should help boost corporate profits over the next few years from what Wall Street considers their current disappointing levels.

The result, say analysts, could boost average price-earnings multiples for all public companies to around 35. The S&P 500 stocks currently trade at an overall 28 times earnings.

The extreme ends of price-earnings ratios for the 14 gaming stocks shown in the accompanying chart are Grand Casinos Inc.'s 7 and Aztar's 110. But except for those two and Starwood Resorts & Hotels (at 48), the P/E multiples range from the low teens to the low 20s, providing potential for a significant upturn.

Commercial banks seeking to compete with the high-yield bond markets jumped into casino financing in the mid-1990s. But increased borrowing by some gaming companies, coupled with plunging stock prices and declining cash-flow margins, has made many lenders wary about financing new casino deals.

That, say some analysts, could be a blessing in disguise, as it will limit the supply of new casinos being built and allow casino operators to concentrate on de-leveraging their balance sheets, using cash flow to pay down debt.

The low stock prices also are prompting stock repurchase programs by companies such as MGM Grand, IGT and Anchor Gaming, all of which generate large amounts of cash. And those low prices make some operators with profitable casinos in strategic locations tempting takeover targets, as occurred in the recent friendly mergers between Harrah's Entertainment and Rio, and Hilton and Grand Casinos.

Much hinges on whether the new resorts opening later this year and in 1999 can draw increased numbers of visitors to Las Vegas. If they do, Wall Street's perception about gaming companies may change.

"Maybe Bellagio will bring in more visitors," says Dave Ehlers of Las Vegas Investment Advisors Inc. "We'll see real quick. But if it doesn't, those 3,000 new rooms will empty out 3,000 rooms someplace else. And that won't help Wall Street's perception at all."

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