Key points

• As billions of dollars are invested in casino developments, long-term investors who are comfortable with the ethics of gambling should look closer at gaming stocks. Their operational performance is improving and some offer better value after recent price falls.
• Crown and Echo Entertainment are the big players, but pokie machine manufacturer, Ainsworth Game Technology, stands out among smaller gaming stocks, principally for its growing overseas footprint.
• Donaco International is a small cap stock for the speculators. It owns the Lao Cai International Hotel in Vietnam and has acquired the Star Vega Resort & Club in Poipet, Cambodia.

“Follow the smart money” is a useful investment maxim. In gaming, that means following the biggest casino development boom in Australian history and positioning portfolios to capitalise on rising Asian and local demand for integrated resorts.

As billions of dollars are invested in casino developments, long-term investors who are comfortable with the ethics of gambling should look closer at gaming stocks. Their operational performance is improving and some offer better value after recent price falls.

The lucky country

Sydney, of course, is leading the casino charge through the massive Barangaroo development on the CBD’s western edge. Crown Resort’s proposed $2-billion hotel, casino and apartment complex, due to open in late 2019, will be Sydney’s second legal casino and create a global international gaming precinct with The Star casino in nearby Pyrmont.

The Star’s owner, Echo Entertainment Group, in July pipped Crown for the right to develop the giant Queen’s Wharf integrated resort in Brisbane. An Echo-led consortium that includes two Asian companies will develop a project that could add $4 billion to Queensland’s economy.

As part of the Queen’s Wharf Proposal, Echo is building a Tourism and Hospitality School on the Gold Coast, and a $345-million redevelopment of its Jupiters Casino, which is underway, will be ready for the Commonwealth Games there in 2018.

The Star has had a substantial makeover. An $870-million refurbishment between 2009 and 2013 added new restaurants, bars and event spaces. The pay-off has been The Star’s improving operational performance, evident in Echo’s latest full-year result.

Skycity Adelaide, owned by New Zealand’s Skycity Entertainment Group, is also being expanded as the city is transformed with a larger convention centre and other big developments. The redevelopment is expected to cost about $350 million.

Crown Perth, at Burwood, is getting a $568-million expansion. A new 500-room, six-storey hotel, due in 2016, will give Crown a bigger presence in the west.

I could go on with other regional or Asian casino developments. The point is clear – casino operators are getting set for the coming boom in Asian tourism, which the Switzer Super Report outlined this month, and for Australian population growth. As Sydney and Melbourne’s populations swell, more people will want to live, work and play in the one precinct.

Investors need to ask whether the valuations of Crown, Echo and Skycity (dual listed on ASX) have captured the upside. Or if smaller players, such as Ainsworth Game Technology and Donaco International, focused on Southeast Asia, offer value.

1) Crown Resorts

Crown is tricky. It has fabulous assets in the Crown Entertainment Complex in Melbourne and Crown Perth; a third interest in the Nasdaq-listed Melco Crown Entertainment, which has assets in Macau; and smaller investments in offshore casinos and online betting.

But it has fallen from a 52-week high of $16.47 to $12.40, principally over fears that China’s crackdown on government corruption is hurting the VIP gaming segment in Macau. Crown’s debt position and potential pressure on its credit rating is an emerging concern for bond investors, although Crown seems to be managing its debt position adequately.

James Packer’s retirement this month as Crown chairman surprised investors, although he remains a director and is expected to retain his executive role.

Crown reported normalised underlying earnings (EBITDA) for 2014-15 of $824.9 million – below market expectation. Beneath the weak headline result was a better-than-expected performance from Crown’s Australian operations and better VIP revenues.

Of 12 analysts who cover Crown, five have a strong buy or buy recommendation, six have a hold, and one a sell, according to consensus estimates. A median share price target of $15.50 suggests 25% upside for Crown from the current price.

Crown has excellent long-term prospects and it is likely the market has overreacted to weaker VIP revenues in Macau. However, it is hard to find a short-term re-rating catalyst to turn Crown shares sharply higher this year. Better news from Macau, an obvious catalyst, seems less likely, for now, and the devaluation of China’s currency could weigh on outbound tourism.

My sense is Crown will get cheaper before it recovers. But it is approaching value territory. Chartists will watch if Crown holds important price support around $12.

Chart 1: Crown Resorts

Source: Yahoo

2) Echo Entertainment Group

As Crown weakens, Echo has raced from a 52-week low of $3.08 to $5.10. In addition to its flagship The Star and Jupiter’s Casino on the Gold Coast, Echo operates the Treasury Casino and Hotel in Brisbane. It divested the Townsville Jupiters Hotel and Casino last year.

Echo’s latest full-year result had much to like. Normalised underlying earnings of $520.7 million for 2014-15 were 24% higher than the previous full-year result and ahead of market expectations. All divisions performed well and The Star was a standout, with 26% revenue growth. Echo shares rallied on the result.

Echo has momentum. The Star is benefiting from its big refurbishment, and a better performance from the main gaming floor could further lift performance.

Solid growth in cash flow and lower gearing, always a good sign, gives Echo greater flexibility to develop The Star and other assets, and prepare for Sydney’s second casino at Barangaroo.

It is hard to know how much a development of Barangaroo’s scale, still four years away, will affect The Star. One certainty is the rise of a global gaming precinct in Darling Harbour/Pyrmont, which should benefit The Star in the long run.

Echo’s Gold Coast casino, a smaller contributor to the latest results has good prospects. Its refurbishment and the Commonwealth Games should be big tailwinds. Longer term, a casino-led hospitality school has great potential. Heaven knows, our tourism industry can do with better service.

Echo has an interesting portfolio of assets: the high-performing The Star that is driving current results, medium-term growth potential from Jupiter’s and long-term potential at Queen’s Wharf in Brisbane. Like all good poker players, Echo is thinking several steps ahead.

Seven of 12 brokers that cover Echo have a strong buy or buy recommendation, two have a hold and three a sell, consensus forecasts show.

Granted, Echo is not cheap on a forecast price-earnings (PE) multiple of 18 times forecast 2015-16 earnings. Sydney’s second casino will be fierce competition; projects in Brisbane and, to a lesser extent, on the Gold Coast have significant execution risk; and Echo has a capital expenditure hump to get over as casinos are built or upgraded.

Nevertheless, Echo is well run, is performing strongly across the divisions, has a good balance sheet, and clear growth prospects in Sydney and south-east Queensland. It can go higher, but is due for a share price pullback or consolidation after recent gains.

Chart 2: Echo Entertainment Group

Source: Yahoo

3) Ainsworth Game Technology

The pokie machine manufacturer, Ainsworth Game Technology, stands out among smaller gaming stocks, principally for its growing overseas footprint.

Ainsworth reported a full-year result that was ahead of market expectation. Underlying earnings rose 20% to $107.6 million in 2014-15, boosted by currency gains and stronger international sales. After jumping 40 cents this week to $3.21, Ainsworth is still below the 52-week high of $3.79.

Offshore growth is the key to Ainsworth and a reason it is among the market’s more interesting small-cap stocks. Always look for small-caps that have a global footprint, or potential to build one. Australia’s size means growth options can quickly expire.

Ainsworth’s international revenue rose 46% to $147.6 million. The division now contributes 61% of total profit. Its American revenue is growing strongly and partly offsetting a slowing domestic market and greater competition.

Ainsworth expects the launch of new products to lift its Australian operations and says strong momentum in the international operations has continued in the first quarter of this fiscal year. It affirmed expectations for “strong organic sales and profit growth in 2015-16”.

Five of six brokers that cover Ainsworth have buy recommendations and one has a hold. Ainsworth has plenty of potential, but suits experienced long-term investors comfortable with higher-risk stocks.

Chart 3: Ainsworth Game Technology

Source: Yahoo

4) Donaco International

Speculators might consider Donaco International. It owns the Lao Cai International Hotel in Vietnam (the Vietnamese Government is a 5% owner) and this year acquired the Star Vega Resort & Club in Poipet, Cambodia.

Southeast Asia has exceptional long-term growth prospects as hundreds of millions of people move into its middle-class. Vietnam, in particular, has arguably the most promising outlook within the region, given its fast-growing, urbanising young population.

Donaco has been well supported by Asian equity funds that hold smaller companies, but conservative investors should stick with larger gaming stocks, Echo in particular.

Chart 4: Donaco International

Source: Yahoo

• Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at August 19, 2015.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.