As I noted in my review of the second quarter, there’s not a whole lot going on in the gambling sector right now – and what is happening is not good. Growth in Macau is slowing down; Las Vegas posted a horrific May; and US iGaming remains bogged down at the state and federal levels.
But the larger problem for gaming stocks is the weak backdrop of the global economy. Rightly or wrongly, gambling stocks are closely correlated with economic sentiment; in fact, as I’ve discussed many times in this column, gambling stocks usually outpace the broad market in good times, and fall farther in bad times.
Proof of this correlation comes from a simple comparison of the Market Vectors Gaming ETF (BJK), a fund comprised of 52 gambling stocks worldwide, and the Standard and Poor’s 500, composed of 500 of the leading stocks in the US market. Below is a graph of the BJK vs the S&P 500 since March 6, 2009, the low point for the US stock market after the 2008-09 financial crash:
Note that as the broad market gains, gambling stocks gain more, notably in mid-2009 and the second half of 2011. In times of economic worry, such as the summer of 2010 and the fall of 2011 – a nearly two-year low for the US stock market – gambling stocks fall sharply, as their total return converges toward that of the broad market. The same pattern has repeated in 2012; after rising over 20% to start the year, well ahead of the 12% gain in the S&P, the BJK ETF is now up less than one percent year-to-date, its return sharply lower than that of the average stock.
The impact of broad market fears on gambling stocks is made clear by the interpretation of recent news in the sector. Yes, Macau is slowing down; but June revenue still grew by 12.2% from the year-prior period, strong growth for any market in any industry. In a bull market, Wall Street equity analysts point to this figure and say, “Macau grew over 12% year-over-year last month; and the mass market segment grew by 30 percent! It’s the largest market in the world and it’s growing at a double-digit clip; buy Macau casino operators.”
But, amid the currently negative worldwide sentiment, the story is different – though the facts are the same. “Macau grew by barely 12 percent year-over-year,” the analysts argue. “It’s much less than we thought it would be.” And Las Vegas Sands (LVS) – one of the first quarter’s best-performing gambling stocks – falls 34% in just over three months.
In a bull market, analysts would recommend patience toward legalization of online gambling in the United States. After all, the value of a stock is (theoretically) equal to the sum of its future cash flows, discounted for the pace of those flows (a million dollars in cash coming in 2020 is worth substantially less than a million dollars today; just ask a bank.) With stocks going up, Wall Street would look at the tortoise-like US iGaming market and argue, “Look: legalization is coming. It may be a year or three later than we would like, but there will be a legalized, regulated, multi-billion-dollar online gambling market in the US in the near future. You can’t miss out on this opportunity – these idiots in government have given you an extra few months to jump in!” With economic fears front and center right now, analysts look at the same stocks and say, “Who gives a shit about 2014? We need money today; the world is ending!”
There’s no doubt that industry-specific news – in particular, the slowing growth rate in Macau – has harmed casino industry stocks over the last two months. Yet many industry insiders argue that the sell-off in these stocks has been massively overdone. Analysts at Goldman Sachs, Nomura Securities, and Cantor Fitzgerald have all argued that Macau-facing operators such as Las Vegas Sands, Wynn Resorts (WYNN) and MGM Resorts International (MGM) have upside of 30 to 40 percent. (I made a similar argument last month, though I still believe MGM is too far in debt to be saved by either Macau or legalized online gambling in the US.)
What has clearly hurt gambling stocks worldwide is the fear the global economy has not yet recovered from the wounds inflicted in the 2008-09 crash. And what that crash shows is just how far gambling stocks can fall when panic hits investors. LVS may seem cheap at Friday’s close of $40.74, well off its April highs over $61 per share. Yet, on March 6, 2009, Las Vegas Sands stock hit an intraday low of $1.38 per share. The company that is now the most valuable gambling company in the world, with a market value over $33 billion and a chairman who is a driving force in US politics, was valued at the bottom at barely a billion dollars. And LVS wasn’t the only gambling stock to collapse in the 2008-09 panic. MGM hit a low of $1.81 per share, versus Friday’s close of $9.78. WYNN traded as low as $14.50 in March 2009; it now seems undervalued at $97 per share, despite delays in its Cotai Strip project and an ongoing legal drama involving a now-removed partner and potential violations of the US Foreign Corrupt Practices Act.
Indeed, looking at the chart of the BJK ETF, gambling stocks as whole roughly doubled in the six months following the market bottom. Over the next two-plus years, the sector grew another forty percent. For investors who bought cheap, the returns were tremendous.
But for investors in the sector now, there are real worries beyond Macau and the patchwork regulations that dominate online gambling in both Europe and the United States. Should real fears about the global economy enter the market, gambling stocks will be crushed. So far, worries about sovereign debt default in Europe and slowing growth in China have dented, but not damaged, worldwide stock markets. Should that change, gambling stocks will likely take a substantial hit, even from their currently depressed prices. Indeed, many gambling stocks look cheap now; but if fear returns to market, they will get far, far cheaper.