3 Small-Cap Gambling Stocks with Big Potential

Earlier in October, the gambling industry held one of its main conferences of the year in Las Vegas, The Global Gaming Expo, or G2E. The event gives gaming professionals the opportunity to see the new products industry suppliers are selling, as well as talk with the companies and their management teams in person.

As an attendee, I had the opportunity to talk to a few industry executives and was able to get a picture of how this industry really works. Below are the three smaller firms that should stand out to investors because of their appealing businesses and growth potential. In fact, I have closely followed two of these companies for a while now, as I detailed back in January.

I truly believe the gaming industry is still in the early stages of what should be a sustained recovery back closer to levels before the financial crisis. This is why I think right now is the best time to get in on this growing market.

1. Gaming Partners
Business: Casino game chips, tables, equipment
Market Capitalization: $54 million
P/E ratio: 10.3

Gaming Partners (Nasdaq: GPIC)
sells game equipment to casinos across the globe, such as gaming chips used at blackjack, poker and baccarat tables; as well as playing cards, gaming tables and furniture. It also sells roulette wheels and dice. Last year, it reported $60 million in total sales, with just more than half stemming from the United States.

The majority of the company’s products are certainly mundane, but its sales are stable and highly profitable. Last year, it generated $7.7 million in free cash flow off the $60 million in sales, representing a profit margin of almost 13%. This is much more than it needs to maintain and grow the company. As a result, cash has accumulated on the balance sheet, which, as of the end June, stood at $9.8 million.

Given the current market cap of $54 million, backing out the cash means investors are placing a value on Gaming Partner’s operations of only $27 million, or only 3.5 times free cash flow — an incredibly low multiple for such a consistent business. In addition, there is significant upside with the development of gaming chips with embedded RFID (radio frequency identification device) technology that can help casinos detect counterfeit chips and ensure payouts are accurate.

To boost organic growth even further, management has worked on an acquisition strategy of companies, products and technologies that can help it diversify and grow its products and services. For example, in July, Gaming Partners purchased OMC Industries, a French manufacturer of plastic-injection molds, giving the company greater control over its chip-manufacturing process.

2. TransAct Technologies
Business: Transaction-based printing, receipts, tickets
Market Capitalization: $73 million
P/E: 13.5

TransAct Technologies (Nasdaq: TACT) helps companies print receipts, tickets and related transactions. It serves a number of industries, including the banking and financial segments, but has targeted the gaming industry as its primary growth driver. This is due to its latest Epic 950 printer model, which is intended to print targeted promotions on slot-machine payout tickets. For the most part, casinos have replaced physical coins by paper-ticket receipts that can be exchanged for real money at a casino’s cashier.

TransAct seeks to add significant new revenue drivers for casino operators. These include comps, coupons and other specials that will send gamblers into stores, restaurants and casino entertainment to supplement gaming revenue. These days, Las Vegas earns about 60% of its sales from nongambling sources. TransAct’s latest offering could help boost its fortunes in this sales segment.

TransAct’s forward price-to-earnings (P/E) ratio is reasonable, given it’s a highly-profitable firm with solid growth potential. Net profit margins came in above 11% in the past year, as management has been able to cut costs and subsequently sell its printers at a higher margin. It is also conservatively managed and has no long-term debt. CEO Bart Shuldman said this gives the company an edge over rivals, because it can offer more lenient payment terms to customers. Growth in the gaming space rose from 30% of 2009 sales of $58.4 million to 41% of 2010 sales of $63.2 million and should continue to push total company sales and profits forward in the future.
3. Shuffle Master
Business: Casino supplies, digital games, slot machines
Market Capitalization: $543 million
P/E ratio: 17.8

As its name indicates, Shuffle Master’s (Nasdaq: SHFL) roots stem from an array of devices that help casino dealers shuffle cards more efficiently. These include a current product line consisting of the i-Deal and Ace shufflers that mix decks of cards on casino games, including the company’s Three Card Poker and Ultimate Texas Hold ’em games. These games form the backbone of Shuffle Master’s current growth initiatives, which are to develop and sell its own table games and a growing selection of games that use a virtual dealer to emulate the look and feel of real-life games. The company presented many of its new games at G2E, which looked to be well received by many of the conference attendees.

Table and electronic games now constitute more than 60% of sales, or roughly $123 million of last year’s total sales of $201.3 million. This is up from sales of only $75 million back in 2006, less than half of the $164 million in sales Shuffle Master reported. Net income is up considerably during this period, and stood at $23.1 million ($0.43 per share), up from $1.9 million ($0.06 per share) in 2006. This has to do with management’s other main focus, which is to control costs while boosting gaming capabilities. Analysts project nearly 11% sales growth this year for total sales in excess of $223 million and earnings per share of $0.57, which would spell an impressive profit growth of 32.6%.

Risk to Consider: The Las Vegas gambling market is the largest in the United States and continues to struggle with low levels of tourism and high unemployment. However, many states, including Illinois and New Jersey, continue to look at gambling as a way to increase tax revenue. Additionally, overseas growth, especially in Asia, has been rapid, though this has been uneven and depends on individual approvals from countries such as China, Singapore and Vietnam.

Action to Take –>
Gaming Partners continues to look like the biggest value play in the gaming supply space. Shuffle Master has arguably the most growth potential, given its aggressive moves into developing and selling its own games. TransAct represents a combination of value and growth, with the growth part of the equation contingent on how quickly casinos adopt its advanced Epic 950 printer. I would rate my own personal level of interest in each of these stocks in this order as well.