Goldman’s downgrade last week contributed to a big drop in IGT’s stock. While we don’t disagree with their macro call, their calculator seems to be malfunctioning.
Here at Hedgeye, we aim to be 100% objective. That becomes more difficult when we uncover data points, research, and/or analysis that may go against our established opinions. IGT is a perfect example. We haven’t been big fans of this name recently – we’re worried about market share on the gaming ops side – but the recent Goldman downgrade has a major hole that we feel obligated to confront.
We certainly share Goldman’s cautious outlook on 2011 for the gaming industry as a whole. Whisper expectations have gotten way too aggressive in our opinion. However, if you think 2011 will not be a year of recovery for gaming, why would you short IGT and keep a Buy on MGM? One follows the other. If you are negative on slot replacement demand, then you can’t be bullish on casino revenues. Slot floors are old – especially at MGM – so any kind of stability or casino revenue growth will spur replacements at potentially a very accelerated rate. Why short a company with 2x leverage and only an indirect correlation with casino revenue versus a company with over 9x leverage and huge operating leverage? You can’t have it both ways.
So GS has IGT’s earnings increasing only $0.04 to $0.88 in 2011. North American new/expansion unit sales should increase at least 30% (excluding Acqueduct) and IGT’s market share will probably be higher since Illinois orders are likely to contain a higher percentage of video poker machines where IGT dominates. Margins should be better and international sales flat to up; so for IGT only to increase 4% as projected by GS, replacement demand would have to actually shrink materially. We think this is highly unlikely.
Thus, even a relative IGT bear finds the GS 2011 estimate way too low. We are currently projecting $1.07 in 2011 EPS and we wouldn’t call that aggressive. Taking out the convertible would add $0.07 to our estimate alone. Following our meetings in Las Vegas this week, we don’t think much has changed for IGT and the sector. Replacements are still up over last year and while new casinos and expansion slot sales will be down in 2010, they should rebound in 2011. IGT’s near term earnings visibility is as good as any other gaming company with the exception of the Macau operators. With the stock down 23% in less than 2 months and now trading at under 15x our FY2011 estimate, we may have to revise our bearish view.