CNBC Stock Blog: On Monday, hospitality analyst Jake Fuller panned which casino stock?

Geography plays a role in the stocks Fuller thinks investors should avoid.

“The big-cap names, companies like Las Vegas Sands (LVS), MGM (MGM) and Wynn(WYNN - Annual Report), (have) a lot of exposure to markets like Las Vegas,” he said.  “Las Vegas, you’re going to see a lot of downward pressure in the short term here.”

What casino-resort company did billionaire Ron Baron recommend on Tuesday?

In this video, Baron recommends Wynn Resorts (WYNN - Annual Report) as well as Ralph Lauren (RL).

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

In March I was bearish on casino operator MGM Mirage (MGM), saying “At an enterprise value of 3.8 times 2007 revenue and 21 times 2007 income from continuing operations, MGM looks about as fully valued as one can imagine. The acquisition of Harrah’s, which recently closed after a year-long process, valued that company at 2.6 times 2007 revenue, and 17 times 2007 operating income. And that deal was launched at the height of the private equity boom. It seems wishful thinking to expect a similar valuation in today’s environment.”

Since then, MGM is down 20% and the S&P 500 is up 5%. Meanwhile, casino operators are not scoring highly in the models I follow. I don’t really have time to analyze any of them deeply, but thought it would be worthwhile to point out a couple of the notable model results.

Ameristar Casino (ASCA - Annual Report)

• Earnings momentum: Negative
• Earnings quality: Negative
• Price Momentum: Negative
• Free cash flow: Negative
• Return potential: Neutral

Pinnacle Entertainment (PNK)

•  Earnings momentum: Negative
• Earnings quality: Negative
• Price Momentum: Negative
• Free cash flow: Negative
• Return potential: Neutral

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

photo credit: lemoncat1

This article is a reprint of my March 5, 2008 RealMoney column

Although MGM Mirage operates casinos across the United States and recently expanded to Asia with its MGM Grand Macau joint venture, more than half its assets are on the Las Vegas Strip. Both the number of visitors to Las Vegas and the number of total rooms in Las Vegas increased by less than 1% in 2007.

After a few years of limited new development in Las Vegas, MGM is looking to kick things up a notch or two. Capital expenditures more than quadrupled from $719 million in 2005 to $2.9 billion in 2007. The total capital costs for two Las Vegas strip development projects are expected to approach $13 billion. Another $1 billion is expected to be spent on upgrading non-casino areas at the Strip resorts and $5 billion more for the MGM Grand Atlantic City.

The situation reminds me of late 1998, when the Asian financial crisis and a slew of new Las Vegas developments (many of which are now owned by MGM Mirage) depressed share prices for the gaming stocks and proved to be an ideal buying opportunity. As happened then, majority owner Kirk Kerkorian has been buying shares recently at prices well above the current levels. Last time, he cashed in handsomely on those bets. Will 2008 be a repeat?

According to the latest 10K, the investments are paying off. “For instance, between 2003 and 2006 we invested a significant amount of capital at MGM Grand Las Vegas…. That resort earned $290 million of operating income in 2007, a dramatic increase from the $127 million earned in 2002. Similarly, we transformed The Mirage…. The Mirage earned $108 million of operating income in 2003; in 2007, The Mirage earned $173 million of operating income.”

Perhaps it is because I just read Warren Buffett’s letter to Berkshire Hathaway (BRK) shareholders, but I thought I should check whether this improvement in operating income was actually a good return on the investments being made. Buffett evaluated two of his business on the basis of pre-tax operating income divided by the total capital required to run the business.

Unfortunately, MGM has a bunch of non-operating items to contend with, and I didn’t like the way the database I use broke out the data. So I decided to use cash flow from operating activities as a proxy for operating income (in this case, after-tax.)

Source: Zack’s Research Wizard, compiled by William A. Trent

I don’t think Buffett would be impressed. In 1997, average net operating assets (NOA) for the year were $1,055 million, while cash flow from operations was $184 – a cash return on NOA approaching 18%. By 2007, average NOA were $16.6 billion and cash flow from operations was $994 million – a cash return on NOA of just 6%.

While it’s true that the current NOA includes substantial investments in long-term projects that aren’t yet contributing to operating cash flow, the trend was heading down even before these got underway. Even if the projects do boost returns on invested capital to prior levels, it will be some time before that happens. CityCenter is not expected to open until November 2009, the other Las Vegas strip development is expected to finish in 2011, and MGM Grand Atlantic City in 2012.

At an enterprise value of 3.8 times 2007 revenue and 21 times 2007 income from continuing operations, MGM looks about as fully valued as one can imagine. The acquisition of Harrah’s, which recently closed after a year-long process, valued that company at 2.6 times 2007 revenue, and 17 times 2007 operating income. And that deal was launched at the height of the private equity boom. It seems wishful thinking to expect a similar valuation in today’s environment.

So I am not optimistic that the 1998 thesis will pan out this time. But while I would sell any existing long position and sit on the sidelines (at least until CityCenter opens), I don’t have the guts to short this name. Kirk Kerkorian’s Tracinda Corporation has the resources to continue funding the developments and possibly to take on a larger ownership stake. Bringing on joint venture partners to co-finance the project has also become a key strategy, with deep-pocketed Dubai World being more than capable of taking up any slack. In fact, taking on Dubai World as a joint venture partner on CityCenter resulted in a $1 billion gain on the investments made to date.

Disclosures: William Trent has no positions in the companies mentioned

First there were the socially responsible funds, which eschewed investments in “dirty” industries related to alcohol, tobacco, firearms, gambling or sex. The backlash, of course, was the “vice fund,” which specifically looks for stocks of questionable moral fiber. To see how the companies in that latter group are faring, I looked at the most recent conference call transcripts for what I consider a representative sample.

Rick’s Cabaret (RICK) shows that sex sells.

To begin the third quarter of 2007 our net income exceeded $1 million, we’re up 62% over 2006. Earnings per share or basic share were $0.17 versus $0.13. Our revenue topped $8.4 million which was up 35% over 2006 and our cash flows are up 52% for the nine months to $2.8 million.

The main driving factors, of course for the club, over the club operation with a gross income of $8.2 million and net income before tax on the club levels of $1.9 million. The main drivers of this is the Ft. Worth location which exceeded our expectations, we closed at the end of April. So we basically have about 10 weeks in the quarter from that location. The Austin and the San Antonio locations are now improving. We were able to cut some losses in San Antonio, although I changed some expenses and actually increased our revenues a little. The Austin Club is continuing to improve, we had a grand opening in August of the second floor of VIP area and we’re hoping to see continued growth there. And of course our New York City location having record months, and we are still continuing to see very strong growth in our New York City location.

Same club, same period, sales were up about 10%, which we’re very pleased with. We hope to continue that trend.

(Excerpr from full RICK conference call transcript)

Meanwhile, Altira (MO) shows tobacco isn’t exactly smoking.

PM USA’s shipment volume of 45.6 billion units was down 3.3% or 1.6 billion units versus the prior year. In the first half of this year Philip Morris USA estimates that total cigarette industry volume declined between 4% and 5%, and it is maintaining its prior estimate of a 3% to 4% decline in total industry volume for the full year 2007….

Turning to our international tobacco business; in the second quarter PMI’s operating companies income increased 4.7% to $2.2 billion, due primarily to higher pricing and favorable currency of $87 million, partially offset by higher asset impairment and exit costs of $76 million.

PMI’s cigarette shipment volume increased 3.3% or 7.1 billion units to 221 billion units, due primarily to the acquisition volume from Lakson Tobacco in Pakistan. Volume gains in several markets, including Argentina, Egypt, Indonesia, Korea, the Philippines and Ukraine, as well as the favorable timing of shipments in certain markets, were partially offset by shipment declines in Germany, the Czech Republic and Russia, as well as Japan, where comparisons to the second quarter of 2006 were distorted by heavy trade purchases in anticipation of the July 2006 excise tax increase.

Excluding the impact of acquisitions, PMI’s cigarette shipment volume was down 0.5%.

(Excerpt from full MO conference call transcript)

Anheuser Busch (BUD) is anything but flat.

Industry sales trends continue to be very good, despite the difficult comparison with the unusually strong first-half of last year when shipments increased 2.9%. Anheuser-Busch’s U.S. market share for the first six months of the year decreased one-tenth of a share point on a shipment basis.

Revenue per barrel increased 3.1% in the second quarter and was up 2.7% year-to-date. Front line price increases contributed 190 basis points to revenue per barrel growth in the second quarter. Promotional price adjustments contributed 10 basis points and portfolio mix was favorable by 110 basis points due to the mix impact from the import brands.

Average promotional prices were higher than the prior year for both the Memorial Day and Fourth of July holidays and we are encouraged about the outlook for the promotional pricing environment for the Labor Day weekend and the remainder of the year.

Consistent with the timing pattern for our 2007 pricing actions, we anticipate implementing price increases on the majority of our volume early next year with a few increases planned for the fourth quarter of this year. As in the past, AB’s pricing actions will be tailored to specific markets, brands and packages.

Our international beer segment net income increased 14% in the second quarter and was up 19% in the first-half, led by Grupo Modelo.

(Excerpt from full BUD conference call transcript)

Finally, MGM Mirage (MGM) is on a roll.

As far as operating results, net revenues increased 10% to $1.9 billion, up 4% excluding Beau Rivage, an all time revenue quarter for the company. Our fundamentals are clearly strong as evidenced by tremendous hotel results and excellent cash flow results across our portfolio of resorts.

As mentioned in the release, we had an all-time record second quarter property EBITDA of $686 million, which represents a 9% increase over the prior year. Las Vegas Strip occupancy percentage of 97.8% was our company’s highest occupancy since 2000. Combined with a strong average room rate of $162, our Las Vegas Strip RevPAR was up 7%. Demand has remained robust and increased visitor volume to our Las Vegas Strip resorts continues to drive revenues.

MGM Grand Las Vegas earned $108 billion of EBITDA which is an all-time record for any quarter in that property’s history, and a 43% increase from the prior year. TI and Excalibur also earned all-time record property EBITDA. The Mirage earned $59 million, a record second quarter which represented 41% increase over the prior year. New York, New York also had a record second quarter. Bellagio had its second-highest ever second quarter property EBITDA against a very tough comparison to the second quarter of ‘06, despite having an abnormally low hold percentage this year and a high hold percentage last year.

(Excerpt from full MGM conference call transcript)

Based on this admittedly selective sample, business is good for sin stocks. Even MO, the lone representative with declining sales, makes up for it with its generous dividend.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.

Mid Cap Watch List (Track at Marketocracy) member Shuffle Master, Inc. (SHFL) announced its results from continuing operations for the second quarter and six months ended April 30, 2007. Revenue, adjusted EBITDA and GAAP earnings per share from continuing operations totaled $44.6 million, $13.7 million and $0.10, respectively.

The Wall Street consensus expectation was for $0.13 on $43 million in sales. Obviously with sales above expectations but earnings below, there was a margin problem:

A decrease in gross margins and operating margins compared to last year. The decrease in gross margins was primarily due to product sales mix, namely the contribution from lower margin sales of Stargames slot product and to a lesser extent, electronic table game sales. Operating margins were lower primarily due to increased R&D at Stargames and to a lesser extent, an increase in overall SG&A to support current growth initiatives.

Last year the company took a large writeoff for acquired in-process research and development when it acquired Stargames. These writeoffs are supposed to represent money paid for the acquired company’s research and development projects that don’t have a predictable outcome. Since this type of expense is not expected to occur often, its amount is listed separately on the income statement and the acquiring company generally asks investors to ignore it. However, an investor might want to consider what it would have cost the company to develop the products itself rather than buy them in process, and assign those costs to future years for comparative purposes.

Apparently, in this case not only did the written-off projects fail to materialize, but even more was spent on unproductive research.

With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Mid Cap Watch List (Track at Marketocracy).

As with the Small Cap Watch List (Track at Marketocracy), we were surprised at the amount of turnover in our screens. Only 7 of the original 29 names made the cut for the new list (which comes in at only 24 names.) Part of the reason for the turnover was to reduce the overlap between the Small Cap and Mid Cap Watch List (Track at Marketocracy)s. Now there is only one-third overlapping names rather than two thirds. Furthermore, given the level of outperformance we saw in the first quarter (actually just two months) and the fact that much of those gains were achieved early, perhaps the turnover is warranted.

So without further ado, the names on the chopping block from the previous list are:

Silgan Holdings (SLGN - Annual Report); Middleby (MIDD); Olin (OLN); Vector Group (VGR); Sanderson Farms (SAFM); Tesoro (TSO); Downey Financial (DSL); Waddell & Reed (WDR); Gamco (GBL); Apria Healthcare (AHG); Quest Diagnostics (DGX); ITT Educational Services (ESI); Equifax (EFX); Delhaize Group (DEG); Papa John’s (PZZA); Rent-a-Center (RCII); Cato Corp (CTR); Dassault Systemes (DASTY); Ingram Micro (IM); Energy East (EAS); South Jersey Industries (SJI - Annual Report); and American States Water (AWR).

The new list is:

When we hosted The Festival of Stocks, we made the following comment on one of the submissions:

Traders Insights looks at MGM and likes what he sees. We must admit, with this cash cow in his stable we were somewhat perplexed as to why Kirk Kerkorian was messing around with something like GM rather than buying out the public float on this bad boy.

From our mouths to his ears?

Tracinda Corporation, the investment firm owned by billionaire Kirk Kerkorian, said it is making a 55 usd per share offer for up to 15 mln shares in MGM MIRAGE Inc, in a deal that could be valued at up to 825 mln usd.

The offer price represents a 12.2 pct premium over MGM MIRAGE’s closing share price of 49 usd on November 21, Tracinda said.

The firm already owns 56.3 mln shares in MGM. If the deal is completed, Kerkorian will own a 61.7 pct stake in the company.

It’s gotta be a better bet than GM.

Today our Watch List names sent a message: nobody is willing to take a gamble.

Shuffle Master (SHFL) was among the day’s top losers, as the company lowered its EPS guidance for the year. Shuffle Master sells chip sorting and card-shuffling machines to casinos, which apparently need to shuffle things less than they were expected to.

Also unwilling to take a gamble are banks. Perhaps concerned over the increasing consumer debt burden they may be taking a more cautious approach to lending. At any rate, credit reporting agency Equifax (EFX) raised its guidance, and the shares were among the big winners today.

With this lack of appetite for risk, companies are rightly concerned about share price. There, too, some are taking no chances. Since a big buyer is needed to get shares moving up, Metal Management (MTLM) found one – itself. That turned out to be a sure bet.