Picking the right defensive stocks will be paramount to investment success this year. Manufacturers are not in this group. International Game Technology (IGT) continues to perform reasonably well for the resources it has, but it is not a stock to hold. It’s not a great short play either, being range bound for 10 years and on the verge of a technical breakout. On a long term chart it looks like it may be set up for a breakthrough, nearing its highest levels since 2008. If the breakthrough happens it would be short-lived and technically driven, but it’s reason enough to hold off from shorting it for now.
Scientific Games (SGMS), on the other hand, has been busy going parabolic for over a year now, exploding by nearly a factor of 10, rivaling bitcoin. Well, not really rivaling it, but this is not stable price action. It won’t last. If you have some spare change hanging around some 2020 puts on SGMS are a good gamble. See if you can hit the jackpot. The $25 strike is going for $2.85 a contract now, and none have been traded since December 4th. Nobody’s in this trade, surprisingly. Puts closer to the current price of $56 are much more expensive. Could Scientific Games fall below $25 by 2020? Sure it can. Look what happened to IGT in 2008. It lost 80% of its value from top to bottom. If that happens to Scientific Games, gains on those contracts would be close to 5x.
Manufacturers are higher up on the production chain than retail casinos who serve consumers directly. Generally, the higher up on the structure of production you are, the harder you are hit when a boom turns to bust. That’s reason enough to avoid both of them.
Both IGT and Scientific Games have subpar balance sheets with heavy leverage. Scientific Games holds $8.2B in debt with a market cap of $5B. And that’s taking into account its monster rally of close to 1000% since January 2016. At basement levels, SGMS would have a leverage of about 1,450%. Bankruptcy in that case would not be out of the question. $4.2B of that debt is unprotected, and interest rates are already rising quickly now. If you want to risk shorting a manufacturer, SGMS is the one to short. Not heavily, but with spare change for decent gains.
IGT isn’t in a much better position with leverage at 136%, and focus in bubbly or dangerous markets. Of its total revenues of $5.1B last year, 34% comes from Italy, 26% from North American gaming, 23% from North American lottery and 16% from other international markets. Of all these segments, North American lottery is probably the most secure from a sudden fall. Italy continues to be a complete basketcase and elections are in 6 weeks. The Five Star Movement, a populist Eurosceptic group of angry people led by a comedian, may actually win. They have been consistently on top of opinion polls all month and now lead their nearest opponents by 5 points. If they do win and then leave the EU, that would cause some serious tremors across the entire world. Falling IGT shares would be the least of anyone’s problems.
As for American markets, the clouds keep darkening. Money supply growth remains far below what it should be at this time of year when it typically grows at the fastest rates of the year. That means by summer, when the annual money expansion slowdown comes, it could trigger the end of the 9-year stock market bull for good. This is not even taking into account the question of debt and interest payments. The election of Eurosceptics in Italy and a slowdown in US markets will do serious damage to IGT, very quickly, just like what happened to its stock 10 years ago.
All this still doesn’t make IGT a great short right now. By the time stocks top, IGT could break through 10-year highs and momentum could drive the stock much higher just because investors are in a bullish frenzy right now. There’s no way to tell how high anything goes during a momentum move, but if you want to try to make a few bucks you can try shorting IGT in March just before the Italian elections. If the Five Star Movement wins, IGT will probably take a decent hit and then you can cover for a quick profit. That would be the safest way to do it.
In the case of Scientific Games though, the rally has gone so far so fast that the stock going any higher just seems goofy. Maybe the high hasn’t been reached yet, but if not it shouldn’t be too much higher than where we are now. Buying a few puts on SGMS, even more indebted than IGT mind you, for 2019 or 2020 and leaving them be for a year is relatively safe assuming you can afford to lose most of what you put in and it won’t give you heart palpitations. Stick to small positions and it will be easier to hold on to if the top is still ahead of us.
