Second-quarter earnings’ season is here and the numbers are expected to be strong for the Las Vegas Strip, though somewhat weaker for regional properties. Question marks remain for the rest of 2022 and heading into 2023 as inflation remains elevated, along with fears of a recession.
“With sustained weakness (namely soaring inflation and gas prices and a downturn in consumer confidence and personal savings rates), we expect to hear more conservative commentary from management teams,” said analyst Barry Jonas of Truist Securities. “The key question remaining is around the potential for a wider, lengthy recession and its impact on the historically resistant industry.”
Jonas said the second-quarter numbers “should be fine, but the outlook seems less certain.” Thus, Truist is lowering their estimates for 2023 to be flat. None of it, however, compares to the late 2000s, he added.
“Stocks have already taken the hit, factoring in coming fundamental weakness, and there’s precedent for stocks being a leading indicator,” Jonas said. “While more rounds of lower-estimate revisions are possible and make valuation-based stock calls more difficult, we don’t have a crystal ball and ultimately think business models and balance sheets are in much better shape today than in 2008. We think patient investors will see strong returns from here, but continue to favor navigating the uncertainty with more profitable gambling-oriented companies.”
Jonas noted how traffic coming to Las Vegas from California continues to decline; it’s down 6% year over year and 2% month over month through May.
“We believe rising gas prices could be starting to have an impact, given that the 4% year-over-year dip is the third straight month with a decline, the steepest to date, and the first decline since Jan 2021,” Jonas said.
For the Las Vegas Strip, Shaun Kelley, an analyst with Bank of America Securities, said his team expects strong second-quarter results given record (revenue per available room) in April and gaming revenue 4% higher quarter over quarter, “but year-to-year comps get tougher in the third and fourth quarters.”
Kelley said commentary on consumer spending will be the “most critical part of earnings,” as investors weigh exit rates, recession concerns, inflation impacts, and flagging confidence. Despite that, they don’t expect “meaningful cracks in demand.”
Gaming stocks have underperformed since the first quarter and are down 25%, along with broader consumer discretionary stocks down 22%, Kelley said. Both are lagging the S&P’s 15% decline.
Strip revenue per available room is 38% higher quarter-over-quarter and has been helped by group business recovering, Kelley said.
As for regional gaming, it faces its toughest comps of the year in the second quarter, and Kelley said they expected property EBITDAR to fall 8.8% year over year, with margins down as well.
Regional-gaming estimates are expected to increase 4% over the first quarter and 14% versus the second quarter of 2019, Kelley said. Sequential growth versus 2019 peaked in April at +19% (helped by five Saturdays), while May/June trends have moderated, each at +12% versus 2019, he said. On a year-over-year basis, May turned negative, while June was flat, “as comps became noticeably more difficult starting in March,” he said.
David Katz, an analyst with Jefferies Equities Research, said the “magnitude of weakness in out-of-favor gaming names” is defined by leverage and digital investment, given the near-term economic uncertainty.
“We broadly favor management teams with execution track records, controllable capital setups, and long-term fundamental positioning,” Katz said. He cited “Churchill Downs and Penn National in the stable regional-gaming group and cash-rich MGM for Las Vegas exposure, all of which prove inexpensive over time. We remain conservative on Macau-related exposure.”
With gaming stocks down about 30% on average year to date, the worst performers are Caesars, down 60%, and Bally’s and Penn, down 45% and 40%, respectively, Katz said.
“We note that part of the sell-off was driven by leverage and the erosion of premiums associated with sports and digital prospects,” Katz said. “In addition, the market has been focusing on any signs of discretionary spending pulling back, given high inflation and rising fuel costs.”
For regional operators, there are challenging comparisons in the second and third quarter, as some markets have seen modest year-over-year declines in gaming revenue, Katz said.
“Nevertheless, we maintain that regional gaming should be resilient during downturns,” said Katz, who added that they’re trimming their 2023 estimates. “Overall, we favor operators with diverse portfolios and more control over core businesses, namely Penn, Churchill Downs, and Golden Entertainment,” Katz said.
Being a destination market, Las Vegas is perceived to be more vulnerable during downturns, especially as gaming revenue dropped nearly 20% between 2007 and 2009, Katz said. That won’t be the case this time, he added.
“We acknowledge that Las Vegas would be more impacted by economic activity pulling back and corporations cutting business travel and conference/convention budgets,” Katz said. “However, we generally believe Las Vegas is in a much healthier state today than in 2008-09, with stable room supply and more headroom in group and convention business recovering. More important, the market today has more sports and entertainment options, with more forthcoming.”
Katz said their top pick for Las Vegas operators remains MGM, which they expect to gain share with its reimagined loyalty program and cross-sell from digital. He said they continue to like Caesars for higher-risk investor appetites, given elevated leverage, as the Strip-asset sale could be a positive catalyst.
As for Macau, visibility remains limited with recent outbreaks, which led to properties shutting down.
“Though some would argue for optionality in Macau-oriented names, given that valuations reflect little to no value for Macau businesses currently, we maintain that any recovery should be more gradual than that in domestic markets,” Katz said.
Jonas said investors will be focused on a forward outlook, with the caveat that management teams can control costs. He said his team continues to favor operators with a higher mix of gambling-related revenues, as well as omni-channel interactive strategies and strong free-cash-flow generation.
“We continue to like buy-rated Boyd Gaming, Red Rock Resorts, and Monarch Casino & Resort for lower leverage, access to strong markets, and real estate ownership, which offer a strong backstop should conditions deteriorate,” Jonas said.
Jonas said buy-rated Penn is well positioned with its drive-to gaming portfolio and developing omnichannel portfolio. It’s likely on a quicker path to profitability than peers.
“Buy-rated Caesars should delever (a key investor focus) with or without the sale of a Vegas asset, while lower losses for digital meaningfully helps,” Jonas said. “Buy-rated Bally’s continues to develop a credible second-mover omnichannel offering, while a leaked UK white paper suggests new UK regulations may be workable.”
Jonas said hold-rated MGM is “showing strong near-term trends, though we have more concerns about Las Vegas should fundamentals deteriorate.”
Hold-rated DraftKings is on the path to profitability potentially sometime next year, though investor sentiment suggests impatience, he said.
Jonas said their analysis suggests the stock market was a strong leading indicator during the Great Recession for the hit to fundamentals, as the market appeared to predict declines in gaming revenue on a three-month lagged basis.
“This is interesting, as on our recent trip to Vegas, operators saw no impact to margins/gaming revenue from macro/inflation conditions, despite the recent stock selloff,” Jonas said.
Truist’s Las Vegas Strip room-rate survey is showing rates strong overall, but the summer months have seen some more recent weakening. MGM and Caesars’ July rates are down 12%/14% from their peak to the most recent survey, and August rates are down 9%/23%. Jonas said, however, that rates have stabilized in recent weeks. “Overall, our survey has shown strength on a year-over-year basis, though comps are getting tougher and third-quarter-2021 growth is now flattish,” Jonas said.
Management teams have characterized the rate environment “as strong, with any rate reductions more just yield management/fine-tuning,” Jonas said. “Additionally, management has cited the return of midweek, with international visitors and the convention business still primed to return in full.”
Jonas said rate reductions were observed in higher-priced hotels in July and potentially driving rate adjustments in lower-tier offerings in later months as consumers trade up.