This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines are dominated by a trio of casino stocks, as investment banker FBR Capital wades into the gambling industry. Let's see where FBR stands:
Betting on two winners... and a loser
FBR leads off with a pair of casino recommendations today, initiating coverage of both MGM Resorts (MGM) and Las Vegas Sands (LVS) with new "outperform" ratings. According to the analyst, MGM offers the most potential for profit -- a potential 28% gain if the stock rises, as predicted, to hit $25 within a year.
According to StreetInsider.com, FBR is predicating its prediction on the fact that "strip EBITDA totaled just 60% of the peak, and that leaves a lot of room for the stock" once gamblers return to Vegas. Plus, the analyst thinks that growth in the new gambling mecca of Macau will benefit MGM through its 51% stake in MGM China and planned Cotai opening in 2016. Further opportunities may arise from licenses MGM has applied for to open operations in Massachusetts and Maryland.
All of which sounds optimistic, of course. But with MGM shares up more than 100% over the past year already, the risk is that much of this optimism has already been baked into the stock. The fact that the stock currently trades for a forward P/E ratio of nearly 93 may be additional cause for worry.
On the other hand, while MGM may not have GAAP profits in its favor at present, what the company does have is free cash flow -- in abundance. Cash profits for the past 12 months mounted up to $632 million, and are growing fast. At a price-to-free cash flow ratio of just over 15, this stock may be worth watching.
Safety in numbers
Las Vegas Sands, in contrast, offers both less reward (according to FBR) and less risk (according to me). FBR's projected $80 share price is only 12% higher than the $71 and change that Sands sells for today. Regardless, FBR says Sands is actually its "favorite name" in the gambling industry.
Why? Well, for one thing, Sands pays a 2% dividend yield, raising the potential profit to 14%. Also, with net debt of only $6.55 billion, the stock seems a safer bet than MGM, which is carting around more than $13 billion in debt, and $11.6 billion net of cash. The analyst also likes Sands' "significant embedded real estate value, a capital return strategy, and real earnings" -- backed up by free cash flow.
Sands is now generating cash profits at the rate of nearly $3.1 billion per year -- more than four times as fast as MGM, on a revenue stream only 43% bigger. At 19 times free cash flow, a 15.5% projected growth rate, and the 2% dividend, I'm not prepared to call the stock "cheap" just yet. But it's definitely in the ballpark.
Odd man out
Of course, the strangest call of all may be the "market perform" rating that FBR hung on rival Wynn Resorts (WYNN) , making it the only stock of the three named so far that FBR doesn't actively endorse.
On the one hand, the analyst warns that the best investors can hope for is for Wynn shares to rise to $175 per share over the next 12 months -- which would be less than a 5% gain. On the other hand, though, Wynn pays the biggest dividend of this group by far, a whopping 4.8% yield. If you assume that Wynn can, and will, continue paying out at this rate (not a certainty by any measure, given that the stock currently is currently paying out more in dividends than it actually earns in profits), then it's hard to see why FBR doesn't like Wynn nearly as much as it likes Sands.
So why is that?
FBR explains: "While the company is a marquee operator with a great balance sheet, free cash flow profile, and capital return story, we struggle with relatively modest near-term growth prospects and a high relative valuation." But I disagree.
Free cash flow at Wynn topped $720 million in the first half of this year, more than twice reported net income. If Wynn keeps that up all year long, the stock's 27 P/E ratio could translate into a price-to-free cash flow ratio less than half that, making it arguably the cheapest stock of the three. True, most analysts agree that Wynn is only likely to grow earnings at about 11% annually over the next five years, the slowest growth rate of the three big casino operators.
Between the extremely strong cash profits Wynn is generating and the generous dividends it's paying its shareholders, I actually think Wynn could be the best bet yet.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.