Three Winning Casino Stocks

Who needs slot machines when you can get bigger thrills by investing in casino operators?

Shares of Las Vegas Sands (symbol LVS) have jumped 37% in September alone through September 27. The stock of rival Wynn Resorts (WYNN) climbed 35% in the same period.

The explanation for the surge is simple: Investors are bullish about Macau, China's only legal gambling destination. Macau, a former Portuguese colony, is getting a Vegas-style facelift. As part of an effort to cleanse what had been a hive of villainy, the Chinese government granted Macau gaming concessions to Las Vegas Sands and Wynn in 2002.

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As a result, modern casino resorts have replaced dingy gambling dens. Las Vegas Sands operates the Venetian Macau, which opened August 28, and the Sands Macau, which opened in 2004. And it has submitted plans to develop six more properties in Macau. Wynn Resorts runs the Wynn Macau, which opened September 2006, and plans a major expansion of its casino next year.

Although the glitzy Macau butterfly has yet to fully emerge from its chrysalis, the tiny island has surpassed Las Vegas as the world's biggest gambling center. In 2006, gambling revenue in Macau soared 22%, to $7 billion. The Las Vegas Strip did about $6.8 billion. Analysts estimate that the gaming business in Macau could hit $10 billion this year.

In a market dominated by high-rollers, operators of Vegas-style casinos in Macau will have to attract the masses in Asia to beat expectations. Two-thirds of gambling revenues in Macau come from wealthy betters known as VIPs. However, the profit margins from VIP betting don't come anywhere close to those by middle-class gamblers attending conventions. That's why Las Vegas Sands and Wynn have built lavish resorts to entice more gamblers to stay longer.

Currently, the average hotel stay in Macau is about one night, according to Morningstar analyst Sumit Desai. Las Vegas Sands and Wynn are "betting that the travel and gambling habits of Chinese gamblers will mimic those of American gamblers over time," Desai says. That may not be such a risky bet. After all, Chinese consumers have rapidly adopted Western-style habits. That's why KFC has more than 1,940 restaurants in mainland China.

But there's more to Asian gambling than Macau. "Macau is just the first chapter in a major growth story developing throughout all of Asia," says Charles Norton, manager of the Vice fund, which holds Las Vegas Sands and Wynn.

Chapter two is Singapore, where Vegas Sands plans to open its first resort, Marina Bay Sands, in 2009. Norton thinks, moreover, that the Japanese government will eventually approve casino gambling, although he doesn't expect the first casinos to be operating there before 2012. Azure USA, a subsidiary of Japanese gaming-machine manufacturer Azure Corp., is a major Wynn shareholder. "Basically, Wynn already has a Japanese partner on its side," Norton says.

Norton calls Las Vegas Sands and Wynn good long-term plays on Asian growth but cautions that the stocks may be due for a pullback. Indeed, buying Sands and Wynn at current prices is like putting rent money on black in a game of roulette. It might work out, but you might not want to risk it.

Sands, which closed at $137 on September 27, trades at a whopping 101 times the $1.36 per share that analysts expect the company to earn this year. The price-earnings ratio, based on expected 2008 profits of $2.71 per share, is only 51.

Wynn shares are no bargain, either. At its September 27 closing price of $166.98, the stock trades at 60 times estimated 2007 earnings of 2.77 per share and 56 times expected 2008 profits of the $2.98 per share. But stocks of fast-growing companies often look expensive. Analysts peg Sands' long-term earnings growth rate at 40% and Wynn's at 29%.

Make no mistake: these are high-risk stocks. With investor hopes this high, there is little room for error. And the volatility that is so rewarding on the upside is devastating when the stocks are sinking. Sands shares, for example, gradually sank from $109 in February to $71 in late June (a drop of 35%) before beginning their current advance.

If Sands and Wynn seem like too much of a crap shoot, consider MGM Mirage (MGM), which has dipped its toe into the Macau market. It has partnered with the daughter of Macau gambling tycoon Stanley Ho to build the MGM Grand Macau, a $1.1 billion casino hotel set to open later this year.

MGM has the newest portfolio of properties on the Strip, including the Bellagio, Mandalay Bay and the MGM Grand. Plus, the company recently struck a $5.1 billion agreement with a company controlled by Dubai to build a resort in that Arab emirate. The deal gives MGM the wherewithal to develop its huge land holdings in Las Vegas and Atlantic City, says David Katz, a gaming analyst with CIBC World Markets.

The shares, which closed September 28 at $89.92, have gained 132% year to date. They trade at 40 times the $2.24 per share analysts expect MGM to earn in 2007 and 33 times expected 2008 profits of $2.73 per share.