Macquarie: Lower Leverage Casino Stocks May Be Rewarded

Broadly speaking, casino stocks aren’t performing well this year, but when investors evaluate the group, they’re showing a preference for less indebted operators.

In a new report to clients, Macquarie analyst Chad Beynon says leverage is reemerging as an “important differentiator” in the gaming, lodging and leisure space as market participants increasingly emphasize factors such as balance sheet sturdiness, free cash flow generation and refinancing risk. Among land-based casino operators, Monarch Casino & Resort (NASDAQ: MCRI) checks those boxes and it has rewarded investors with a 19% year-to-date gain.

Offenders in the most levered camp include Bally’s (NYSE: BALY), Century Casinos (NASDAQ: CNTY) and Full House Resorts (NASDAQ: FLL) – all of which have seen their shares drubbed this year. Century recently sold a pair of Canadian racinos in an effort to reduce debt.

Some Casino Stocks Affected by Looming Maturity Walls

High interest rates are likely the primary reason why casino stock investors are placing renewed emphasis on operators’ leverage. With borrowing costs elevated, interest expense on any variable rate debt issued by companies rises. So does refinancing risk.

Said another way, gaming companies looking to borrow today to pay down debt coming due in the future may be confronted with higher interest rates that diminish the appeal of those refinancing efforts. That situation may be amplified because many prospective borrowers in the casino industry are junk-rated, meaning any corporate bonds they issue will carry higher interest rates to compensate investors for added risk.

Refinancing risk is likely on the minds of credit and equity investors, because as Beynon points out, several major casino operators, including Bally’s, Caesars Entertainment (NASDAQ: CZR), Las Vegas Sands (NYSE: LVS), MGM Resorts International (NYSE: MGM) and Wynn Resorts (NASDAQ: WYNN), “face meaningful maturity walls over the next three years.” Combined, that quintet has $20.5 billion in debt maturing over the next three years.

“While larger issuers maintain ample access to capital markets, refinancing costs are likely to remain well above pre-2022 levels, limiting the benefit of future debt issuance,” adds Beynon. “At the same time, interest coverage ratios remain challenged for several smaller-cap operators, with FLL (0.8x), BALY (1.0x), and CNTY (1.2x) offering limited cushion against potential operating volatility.”

Project Spending Crimping Debt-Reduction Efforts

Amid a volatile fixed income environment, investors evaluating casino stocks may be apt to embrace the companies that are generating free cash flow to naturally reduce leverage while eschewing the operators with significant capital commitments.

That may be bad news for operators such as Bally’s (Chicago, New York), Full House (Illinois) and Wynn (UAE), among others, that are in the midst of substantial capital spending cycles.

“As a result, two companies with similar leverage ratios may trade at materially different valuations depending on future capital commitments and the expected duration of project spend,” concludes Beynon. “In our view, the market is increasingly distinguishing between leverage that is naturally declining through FCF generation and leverage that remains structurally elevated due to ongoing investment requirements.”