Reality Has Taken a Backseat in This Sector

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If investing is considered gambling, then what exactly do you call investments made on companies that profit from gambling? There's a thought that'll have you losing sleep!

The gaming sector, primarily made up of Macau, Las Vegas, and Atlantic City, has seen one of the biggest about-faces in corporate history. While most casinos were nearly wiped off the map during the heights of the recession, many stocks are now making a full recovery from the lows of March 2009. But this turnaround is also my primary concern. Not only have certain casinos made a full recovery, but they are trading at valuations that predicate strong growth that simply isn't there.

Taking a look at the figures out of Atlantic City recently illustrates how weak the domestic gambling market is at the moment. Overall gambling revenue fell 5.9% for February over the year-ago period, according to the state Division of Gaming Enforcement. For the first two months of the year, revenue is down 6.6% from 2011. This is bad news for Caesars Entertainment (NYS: CZR) , which relies on domestic gambling for 95% of its revenue. Mired under $19.8 billion in debt, Caesars' revenue in Atlantic City fell 7.7% in February, with Bally's dipping an even worse 10.4%.

In Las Vegas, things sound better than they actually are. In January, gambling revenue in Nevada hit $1 billion, which is 18% higher than the previous year. But before you go jumping for joy and betting your savings on black, keep in mind that Chinese New Year landed in January this year and had a major seasonal effect on gambling revenue. In actuality, slot revenue on the Strip fell 0.44% in January, signaling continued weakness.

Las Vegas Sands' (NYS: LVS) recent quarterly report indicated a 9.3% rise in revenues for its Las Vegas properties, but baccarat, a game aided by Chinese New Year, accounted for much of that increase. For MGM Resorts (NYS: MGM) , which reported its full-year results in late February, net revenue -- excluding the recently opened MGM China -- rose just 7%. MGM hasn't produced an operating profit since 2007, and according to Wall Street's estimates, it could be at least another two years before it does so again.

Macau continues to be the one bright spot for all casinos, with gambling revenue across the region gaining 22% in February and 47% in January over the year-ago periods. Wynn Resorts (NAS: WYNN) posted a 9.1% revenue increase in Macau and has managed perhaps the best track record for sales growth in the U.S. Similarly, Melco Crown (NAS: MPEL) saw its Macau casino revenue pop 35% in January.

But has excitement about Macau completely gotten the better of investors? I'm tending to think so.

Wynn Resorts has been the most consistent casino play, but even that looks pricey at 17 times book value. The other plays mentioned above look downright scary on paper. MGM has had several years of losses, Caesars is barely covering its interest payments, and both Las Vegas Sands and Melco Crown are trading at a brisk 37 times earnings. The growth in this sector simply doesn't match up with the values being assigned these stocks. Reality has indeed taken a backseat to Macau-mania, and I for one don't want to be around when double zeroes pop up on the investing roulette table.

Disagree with my bearishness on gaming? Sound off in the comments section below and consider adding these stocks to your free and personalized watchlist.

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At the time this article was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He always bets on black. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that makes sure you're always a winner.

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