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It’s Slim Pickings for US Gaming Stocks

TAGs: Editorial, Rafi Farber, US Gaming Stocks

It’s Slim Pickings for US Gaming StocksUS stocks look set for another leg up starting tomorrow when the Fed will almost definitely balk yet again at raising interest rates. If it doesn’t and by some miracle raises interest rates by a measly quarter of a point, stocks will tank and it will present a great buying opportunity. Unfortunately for the US gaming sector, it’s slim pickings right now even with stocks likely about to move higher.

The big names like Penn National Gaming and Pinnacle Entertainment have already spun off their real estate holdings into respective REITs in order to unburden themselves of considerable debt, but it hasn’t done much to help their respective situations. It’s like when Jerry Seinfeld made his national debut in 1981 on Johnny Carson with his routine on the 1,400lb man. Let’ say he loses 200lbs. “If you’re a friend of his, what are you gonna say to him? ‘You know you look great Bob! What are you down to, 1,200 now? You’re a rail baby, look at you!’ And what can he possibly say in response? ‘You know, I feel terrific!’?”

If we look at Penn, interest expense is already at $115 million quarterly and leverage is still at 470% despite the 2013 REIT spinoff. Even a small uptick in interest rates will crush any growth they currently have. Core inflation in the US is already passed the Fed’s official target of 2%, and has been above target since December 2015!

It’s Slim Pickings for US Gaming Stocks

Does anybody talk about this? Not really. And why is the target 2%? Because that rate of inflation is not very noticeable. People don’t kick up protests over it. But when it is 3%, which could be any month now, the Fed will start have to start chasing with interest rate hikes, but they won’t help. In order to tackle inflation with interest rate hikes, the hikes have to step in front of the inflation rate, which would push the Fed Funds rate to 4%, for a move 350 basis points. Let’s see how Penn and Pinnacle deal with something like that.

If we look at Penn’s price action, it doesn’t look too encouraging. Very near its lows, which would be a good sign if it were actually healthy, it doesn’t seem to follow general market trends. It looks like a chart slowly bleeding. There is no reason to risk any capital on this one, so leave it alone. When inflation ticks up to 3%, consider shorting it.

Pinnacle is even worse at 550% leverage and total expenses exceeded $1,000,000 last quarter. Even excluding good will impairment, the casino is still operating at a loss. SG&A expenses shot up last quarter without any concurrent rise in the top line, a pretty bad sign for a company drowning in red ink. Any position in Pinnacle would be strictly a gamble with inadequate return for the risk. No dividend, low growth prospects, it’s an accident waiting to happen.

Boyd is in the best shape comparatively of these three, but it is still on a debt treadmill barely keeping up. Levered “only” 186%, it could be considered obese rather than mordibly obese. It basically broke even last quarter discounting income from discontinued operations. It could be a short term buy if it was at a low, but it is much closer to its highs. If a position can be taken it is wiser to buy in-the-money calls at the lowest strike available going out to March 2017, because the general stock market should trend higher by then and Boyd does seem to follow beta trends generally, while the Penn and Pinnacle charts look more like a dying pulse. $860 can get you the equivalent of 100 shares with 1 contract at a $12 strike, whereas you’d have to lock up $1,860 to buy the same amount of shares straight up. The contract should move more or less in tandem with the stock itself since it is far in the money, and the discount against holding the shares makes up for the time premium. This is still risky of inflation picks up fast by March, but $860 really isn’t that much even if Boyd completely crashes and you lose everything, not likely at this point.

MGM, which we have traded in and out of several times successfully and is currently still in the portfolio, is the only one of the four with debt below market cap, and the only relatively safe stock that should do well with the rest of the market going into May. Continue to hold this one. Its interest expense is still an issue, but only a minor one compared to its operating income which is over 4.25x higher. MGM is not in any immediate danger of drowning in debt payments, whereas Pinnacle and Penn both are, very much so, and Boyd is teetering on the danger zone.

To take advantage of the probable boom ahead then in US markets, hold on to MGM and look for smaller gaming companies with healthy balance sheets and consistent profitability. Now is not the time to be picking up highly levered companies. It would be if the market has just crashed and a big bounce was imminent across the board, which is why we picked up these companies back in January for a quick trade and sold them in June. Now is not the time to try that again.

However, if the Fed does surprise markets tomorrow and announces a 25 basis point rate hike against all expectations, then yes, all these stocks could be bought for a quick trade as everyone panics, say about a month hold or so. So for now, keep cash levels high, and only buy a 3%-5% position in each if the Fed decides to hike rates tomorrow and everything temporarily tanks. Then get out of them all except MGM once you hit 8%-10% gains on each position.

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