Casino Stocks Are a Risky Bet Right Now

Gaming stocks have been on a tear in the past year as a result of continued growth in Macau. But stock gains have vastly outpaced revenue growth, and with higher stock prices come higher expectations for future growth.

LVS Total Return Price data by YCharts.

What's important is to look at whether these stocks are a good value now. While there's growth ahead, these stocks don't provide the upside they once did, especially Melco Crown and Las VegasSands , which are the most expensive right now. Here are a few reasons to be concerned that gaming stocks have gone too far, too fast.

Not much value left in gaming
There's no doubt that Macau's growth has been great for the operations of gaming companies, but multiple expansion has also contributed a lot to stock gains. Below, I've provided the enterprise value divided by EBITDA ratio, a metric of value in gaming, for Las Vegas Sands, Melco Crown, Wynn Resorts , and MGM Resorts . These are the U.S.-traded operators in Macau, and they're all more expensive today than they were a little less than two years ago, when Macau was coming off a year of 42.2% growth.

Source: Company earnings releases.

What's interesting about the increased ratios is that Macau isn't growing as fast as it was when it was smaller and less developed. Macau won't likely go backward in the near future, but the days of 50% growth are long over, and that reduces upside at these prices.

Macau's days of 50% growth are over
Macau had another outstanding year in 2013, with gaming revenue of $45.0 billion, up 18.6% from a year ago. That still outpaced 13.5% growth in 2012, but was below 42.2% growth in 2011, and the long-term trend is moving lower.

The sheer size of Macau's gaming revenue is now a challenge. To put Macau's size in perspective, the small region generates more gaming revenue than all of the U.S. combined. With the Chinese economy growing 7.7% in the fourth quarter, Macau can't grow 20% every year, even with improved infrastructure.

I'm not suggesting Macau won't grow significantly over the next few years, I'm just saying the prices gaming stocks are currently going for suggest there will be more growth than we'll actually see. Double-digit growth would be outstanding, and that will be harder to reach as the region grows.

Competition is coming
The final challenge to consider is that competition is coming, both within Macau and around Asia. Melco Crown will open one of four major resorts in the Philippines, South Korea is expanding gaming, and Japan may open its doors to gaming as well. There's even been talk about another gaming region in China.

Within Macau, all six concessionaires are building new resorts or expansions on Cotai that will draw customers away from the existing resorts. Unless Macau's gaming revenue grows enough to cover this expansion, it's likely revenue will be cannibalized from existing resorts. 2015 is when new resorts will begin opening, and 2016 will see a number of new Cotai resorts, so keep an eye on growth this year to get an indication of how results will be affected.

These new resorts will put additional pressure on the Macau Peninsula as well as take share from other Cotai resorts.

Foolish bottom line
Rising stock prices in gaming have increased the risk investors face in Macau. The industry needs to see continued gaming growth in the teens just to justify current valuations, and that's a high bar considering how large Macau already is.

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The article Casino Stocks Are a Risky Bet Right Now originally appeared on Fool.com.

Fool contributor Travis Hoium has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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