Weak economy trumps casino stocks

Investors who bet on companies that offer gambling in Las Vegas aren't used to losing money.

Historically, Vegas has been relatively immune to the problems that plague the broader economy. Last year, for instance, while the rest of the economy was starting to crack, shares of the largest Las Vegas casino operator, MGM Mirage mgm, gained 47%, and that after a 56% gain in 2006.

But now the realities of a slower economy are starting to affect Las Vegas, and that's bleeding into the casino operators' stocks. Higher energy costs, which translate into pricier flights and drives to Las Vegas, and less-confident consumers have injured gaming stocks — and stripped their traditional reputation as havens in tough times.

"The credit crunch and housing crisis have been a double whammy that really hit the consumer and, in turn, hit discretionary spending for gaming," says Tom Marsico, portfolio manager at Marsico Funds.

The latest evidence came Monday, when Tropicana Entertainment, the privately held operator of the Tropicana casinos in Las Vegas and Atlantic City, filed for bankruptcy protection. MGM, the largest publicly traded casino, also shows the pain. The stock is down 38.3% this year, on track for its largest annual decline since it started trading in 1989.

Factors behind the problems for Vegas include:

•Falling room rates. To keep visitors coming and to help defray the higher travel costs, Las Vegas casinos have been slashing room rates, says Robert LaFleur, analyst at Susquehanna Financial Group.

Average room rates are down as much as 15% from last year, he says. The average room rate was down 5.1% in February from a year earlier, the latest official data available from the Las Vegas Convention and Visitors Authority. Even a small decrease in room rates has a direct effect on how much casinos earn. Traditionally, casinos make 70 cents of every $1 in room charges, but that margin is being eaten into by the lower room rates, LaFleur says.

Room rates are critical because Las Vegas has become more of a full-service resort and less of a quick stop for hard-core gamblers. That means room rates have been an increasingly big piece of profits. Las Vegas casinos get 58% of their revenue from things other than gaming, including room charges, says Esther Kwon, stock analyst at Standard & Poor's. "The business is more about non-gaming amenities," says Joel Simkins, analyst at Macquarie Securities.

•More competition. Las Vegas gaming operators used to have a near monopoly. But the rise of Native American casinos and other gaming alternatives, such as horse-racing tracks with slot machines, have given gamblers other options. The number of slot machines in North America has ballooned from 150,000 in 1991 to 900,000, Simkins says.

Gaming revenue in the Las Vegas area, including the Strip, fell 4.1% in February, says the Las Vegas Convention and Visitors Authority. "You see more competition, and it will just increase," Kwon says.

•Difficulty accessing capital. The credit crunch has hammered Las Vegas, especially new projects. At least two new projects on the Strip have halted, Kwon says. That includes the Cosmopolitan, a casino being built near MGM, which is stalled as developers negotiate with lenders, Kwon says. Another development, The Plaza, being built on the site of the former Frontier, is also shelved.

There are looming dangers, too, that some other even bigger projects may face financing issues. Boyd Gaming byd, for instance, is building the Echelon and will likely need additional financing, Kwon says.

And that's a stress on a company already dealing with weakness across the board. On April 29, it reported a first-quarter loss from continuing operating of $32.6 million, down from a $35.1 million gain a year earlier. And that perhaps explains why Boyd's stock has been punished amid the downturn. The shares have lost 43% this year alone.

But Boyd is by no means the only point of pain for gambling investors. MGM on Tuesday reported 30% lower net income of $118 million. And shares of Las Vegas Sands lvs, operator of the Venetian casino, are down 27.6% this year. Higher-end casino operators, such as Wynn, have been hurt less. Wynn shares are down 4% this year.

But now, even the gambling equipment makers, which had been dodging the pain because they sell all over the world, are feeling the pinch. International Game Technology's igt shares have started to fall this year, losing 21% of their value.

Few analysts expect Las Vegas to rebound soon. Simkins expects the rest of 2008 to be difficult, as skyrocketing gas prices and the weak economy keep consumers in a bad mood. LaFleur says Vegas depends on many of the same things that the broader economy's recovery hinges on.

But Marsico remains optimistic. He hopes oil prices don't go much higher from current levels and Congress will find a way to sort out the housing mess. Plus, both Wynn wynn and Las Vegas Sands have casinos in the faster-growing Asian gaming market. "There is light at the end of the tunnel, while before, it was gloomy," he says.