MARKET WATCH: What’s Happening? Casino backers say they’re optimistic heading into 2017. The industry has mounted a steady comeback since the Great Recession. Now, with a former casino owner as the POTUS and the all-important gambling market of Macau finally rebounding, forecasters and industry trade groups are predicting a banner year.
Our Take: Overall, the optimism is overblown. U.S. commercial casinos continue to post YOY global revenue and earnings losses—and the industry is challenged by unfavorable demographics and generational turnover. Still, though many casino stocks are overpriced, U.S. companies that are well positioned abroad and that invest in Millennial-friendly attractions may be able to beat their current valuations.
THE BULL CASE
There’s plenty of reason to bet on casinos.
Sure, the industry (like many others) was floored by the Great Recession. Casinos were flying high in the mid-2000s, but came crashing down during the financial crisis. From peak to trough, share prices of industry heavyweights like Wynn Resorts (WYNN), Las Vegas Sands (LVS), MGM Resorts (MGM), and Boyd Gaming (BYD) lost nearly all of their value.
But ever since, casino bulls have spoken of an industry that is on an (albeit bumpy) overall trajectory of recovery. After mounting a comeback from 2009 to 2014, casinos were pummeled by the Chinese government-led crackdown on the massive VIP casino business in Macau, where giants like Sands, Wynn, and Melco Crown Entertainment (MPEL) earn much of their revenue. But no matter: Just one year later in 2015, U.S. commercial gaming revenue hit an all-time high of $38.3 billion. In fact, 2015 was the first year since the Great Recession that a majority of commercial casino establishments (61%) experienced YOY revenue growth.
The optimism has been ratcheted up a notch in 2016. First came the re-emergence of Macau’s casino market: Following 26 straight months of declining gaming revenue, Macau has posted four straight months of growing revenue dating back to August. The region’s old high-roller, VIP-centric business model may be gone—but that hasn’t prevented Wynn and Sands from breaking new ground on resorts in Macau since August.
Next came the election of Donald Trump. Though casinos didn’t immediately get swept up in the “Trump rally,” rising consumer confidence post-election could kick-start discretionary spending (along with casino revenue) in the months to come. Plus, prominent casino operators have long backed the GOP—and now a former casino owner occupies the Oval Office. The American Gaming Association believes that the Trump administration “will feature significantly more restrained federal agencies” than has been the norm under President Obama.
THE BEAR CASE
But let’s be honest: It’s time to pump the brakes. Casinos are still losing money globally. YOY revenue and EBITDA growth for the casino and gaming sector sits in negative territory, where it’s been since mid-2015. The last time such a prolonged negative stretch occurred was way back in 2009-2010.
Even the growth that has occurred over the post-recession period has been a temporary boost from new casino operations in nontraditional gambling states. The UNLV Center for Gaming Research reports that since 2012, casino revenue has surged at a CAGR of over 20% in states like Maine, Ohio, and Maryland. Rather than spurring organic growth, these operations (in part) cannibalize growth in surrounding states by offering existing gamblers a closer option. While these new gambling sites approach full capacity, states like Nevada and New Jersey are suffering from unused capacity—bad news for giants like MGM and Caesars Entertainment (CZR) that earn the lion’s share of their revenue from the Vegas Strip.
So what has been weighing down the industry?
Generational change: Xers are too few and too cash-strapped. The vital midlife age bracket that historically has fueled casinos’ growth is no longer filled primarily by Boomers—but by Xers, whose numbers are smaller and whose household net worth is in much worse shape. For everyone but the gambling addicts, casinos are an extravagance. With kids entering college and retirement ahead, most Xers are cutting back on extravagance.
What’s more, casinogoing simply isn’t a must-do for Xers, even those who do visit Las Vegas: According to a 2015 analysis of Las Vegas tourists, just 68% of 34- to 49-year-old Las Vegas visitors gambled while on their trip—compared to 78% of 50- to 68-year-olds and 87% of the 69+.
Generational change: Millennials are too risk-averse. Generational turnover will soon become an even bigger issue. Whereas most Xers at least are comfortable taking risks, most Millennials are not—which is a huge problem for gambling.
A July study of Millennial travel habits (with responses concentrated in gambling-heavy states like New Jersey) found that just 9% of the average 21- to 35-year-old’s travel budget is dedicated to gambling, compared to 24% of the average 36+ budget. Separate Las Vegas tourist data show that in 2015, Millennials comprised 22% of all Las Vegas visitors—but that only 4% of these visitors cited gambling as the primary reason for their trip.
This generation’s aversion to gambling is a major reason why tourists to Las Vegas aren’t getting any younger despite the new emphasis on glitz and spectacle outside the gaming floor. The average age of a Las Vegas tourist hit 47.7 years old in 2015, the highest figure since 2011—at the tail end of the recession when only crazy Boomers were spending their discretionary income at the slots. This late in the economic cycle, casinos were banking on having a growing flock of younger customers to build upon. They’re not getting them.
To be sure, Millennials haven’t yet hit their prime spending years—but their lukewarm attitude toward gambling goes deeper than their phase of life. Whether it’s casinos, bars, or nightclubs, Millennials are rejecting all of the edgy establishments that Boomer and Xer young adults once enthusiastically patronized. If they’re going out on a Saturday night, it’s not to get wasted and lose money—it’s to hang out in a safe space with their friends. (See more on this phenomenon here: “Where the Wild Things Aren’t.”)
SEARCHING FOR A WINNING FORMULA
Many casino operators are trying to meet these generational challenges head-on.
Creating a Millennial-friendly atmosphere. Some are retooling the casino floor for Millennial customers. Lawmakers in Nevada, New Jersey, and Massachusetts have passed legislation allowing casinos to roll out skill-based, arcade-style games. Penn National Gaming (PENN) took a leap of faith in August with its $60 million purchase of social casino game developer Rocket Games.
Many of these machines look and feel more like a video game than a traditional slot machine—a welcome breath of fresh air for young consumers who don’t share their grandparents’ love of the slots. In fact, as one industry analyst puts it, “You have as much chance getting a Millennial into slot machines as you do getting your grandmother into playing Halo.”
Winning over Millennials is about more than just coming up with new games, however. Rivers Casino offers a “party pit” featuring table games at lower buy-ins in hopes of fostering a social, Millennial-friendly atmosphere. San Diego’s Pala Casino features an underground “wine cave” for young oenophiles in search of a unique experience. (Millennials account for an amazing 42% of wine drunk in America.)
Branching out into “family-friendly” spaces. But there’s only so much that casinos can change about the experience on the floor. As I’ve mentioned elsewhere (see: “Gambling Faces Uncertain Odds”), younger consumers increasingly view gambling as a diversion, not a pastime. Millennials need something else to do besides sitting at the poker table.
As a result, many casinos are pinning their hopes on expansive resorts that offer something for the whole family, including the extended family. (Casinos, historically, have been family-phobic: Recall the famous Las Vegas brand line, “What happens here, stays here.”) Wynn, for example, is building a massive Massachusetts casino-resort that will include eight restaurants, a five-star spa, and 140,000 square feet of retail space. For its part, MGM derives more than 60% of its U.S. revenues from non-gaming sources like fine dining and entertainment.
This movement is part of a larger industry trend: The biggest casino locales are making less and less of their money from gambling. In the 1990s, 58% of Strip resort revenue came from gambling. Now, that share is down to 37%.
Targeting the Web as their next big revenue stream. Still others are taking advantage of new rules that allow them to set up online gaming marketplaces. In 2012, states were given the authority to legalize online casinos within their borders. Regulated online casino operations are now up and running in Nevada, New Jersey, and Delaware—while forecasters predict that five more states could join in by 2020.
In 2015, online gambling’s second full year of operation, revenue from this segment grew 19% YOY to $160.7 million—with growth expected to keep pace until at least 2020. While many these sites are run by U.K. Web firms, traditional casino operators like Borgata (owned by MGM) and Caesars are also in the mix, with other brick-and-mortar casinos eager to join in.
There are early indications that younger consumers may be warming up to online gambling. A U.K. Gambling Commission report found that in 2014, 19% of U.K. Millennials used remote gambling sites—up from 15% in 2008. (Rules permitting online gambling have been around for far longer across the pond.)
CASINO STOCKS TO TARGET
While U.S. casinos with a heavy Chinese footprint (Wynn, Sands, and Melco Crown Entertainment) are set up well if Macau’s gaming market continues its recovery, some smaller regional competitors also merit consideration.
Boyd Gaming’s ROE now sits at 28% LTM—which beats what investors can get from the likes of Sands and MGM. Meanwhile, Penn National’s shrinking P/E ratio, growing earnings, and focus on social gaming may make this company a solid buy. Motley Fool analyst Seth McNew recently listed Isle of Capri Casinos (ISLE) right up there with the big guys as one of five casino stocks to own, citing its low P/E and its high sales and earnings growth.
While casinos appear to have the deck stacked against them, the ones that can successfully navigate a difficult generational terrain are a good bet. To be sure, getting Millennials onto the casino floor doesn’t necessarily mean that they will spend money. (That’s one reason why Penn National CEO Tim Wilmott says that he is betting on Generation-X empty nesters, not Millennials, to fuel his company’s growth in the coming years.) But by offering a friendly, social entertainment experience that young consumers can enjoy, casinos may just hit the jackpot.
