2 Gambling Stocks You Can’t Afford to Ignore

With such a slow economic recovery in the United States, many states are getting creative in how to increase their tax bases. Politicians read the news headlines and are well aware that gambling has taken off in parts of Asia, including Macau and Singapore. Current estimates are that Macau’s gaming revenue reached $33.5 billion in 2011 and grew 42% compared with 2010 levels. The top 20 markets stateside brought in $31 billion in gaming revenue, and politicians are starting to wager that there is plenty of room for new domestic casinos.

That’s good news for investors in gambling-related stocks.

Recent headlines are indicative of the coming wave of new gambling destinations. A bill in Florida is set to approve the building of three casinos in the state. A study in Kentucky has estimated that allowing casinos at eight racetracks throughout the state could bring in $1.1 billion in sorely needed annual revenue. New casinos in Pennsylvania helped gaming revenue jump 22% to $3 billion in the state last year. Indian-based casinos also continue to expand across the country, including the Hard Rock casino brand owned by Florida’s Seminole tribe.

Clearly, the large casino operators, including Wynn Resorts (Nasdaq: WYNN), Las Vegas Sands (NYSE: LVS), and Caesar’s will garner a high percentage of the action in terms of contracts awarded. But they’ll have to compete with Indian casinos and also split contracts with state and local governments. The same can be said about overseas governments.

Given the uncertainty of how that might play out, your best bet is to invest in the leading gaming suppliers. Regardless of how revenue is shared, their slot machines, table games and related supplies are an indispensable part of every casino built.

Here are two solid bets for your portfolio…

1. International Game Technology (NYSE: IGT)
Market cap.: $5.1 billion

International Game Technology is the largest gaming supplier in the industry. The stock represents somewhat of a turnaround opportunity as a couple of smaller rivals have stolen market share from IGT in recent years, however, it is still the undisputed industry leader (it has a 50% market share) and is able to use its clout to earn a percentage of the revenue its casino customers earn on their casino floors.

This variable cost component represented 55% of last year’s sales and allows for considerable upside, given the expectations for higher industry revenue going forward.

The remaining 45% of sales consist of the traditional sale of slot machines and related gaming devices. Its most popular game remains Wheel of Fortune, but it has a very strong product pipeline that includes new versions of its Sex and the City-themed games. Growth trends should pick up considerably going forward, due to new games and favorable industry trends. Analysts project sales growth greater than 7% for this year, total sales of $2.1 billion and earnings of $1.06 per share. This represents a forward P/E of 16, which is reasonable, given growth should only pick up.

2. WMS Industries (NYSE: WMS)
Market cap.: $1.2 billion

WMS Industries sells reel-spinning slot machines and video lottery terminals, which is what slot machines have evolved into because they contain software that can be constantly updated and revised. Basically, it helps keep the action going on gaming floors and has become an industry standard. WMS considers itself a pioneer on the casino floor and offers popular current themed games including “Monopoly,” “Lord of the Rings” and the “Wizard of Oz.”

Last year, WMS reported $783.3 million in sales. The company has grown annual sales at close to 12% during the past five years. Profit growth has been even stronger during this same period, averaging close to 17% and reaching $81 million, or $1.37 per share last year.

Because domestic growth trends are just starting to take off and IGT will steal back some share, analysts project a slight fall in sales for 2012, however, they expect modest earnings growth of 12% to $1.53 per share as international growth remains robust.

As with the industry itself, WMS has global growth potential. Last year, 39% of sales stemmed from overseas locations including Australia, China and India. The forward P/E of about 14 is quite reasonable, given WMS should return to posting double-digit sales and profit growth, which it should be able to sustain for at least the next five years, on average.    

Action to Take –> Given the continued international growth and acceleration of domestic gaming trends, I think the gaming supply industry qualifies as one of the most compelling growth opportunities around. I recommend investing in the largest players in the industry, as they have the clout and sales forces to compete for every new casino contract. Even though it is a turnaround play, IGT is the largest by a wide margin. WMS remains a solid growth play and is roughly the third-leading provider in the industry.