The Motley Fool

Fool’s Eye View: Making Money From Casinos

If you think of casinos as an indoor amusement park for adults, then you probably won’t go too far wrong.

But instead of rollercoasters and spinning teacups, the thrills that casino customers are likely to experience are slot machines that could, if they are lucky, spit out buckets of change or hear howls of delight as a blackjack croupier draws a card and goes spectacularly bust.

But casinos are not only about games of chance. Many casinos have deliberately diversified their businesses to include shopping malls, theatres, restaurants and bars.

However, their main source of revenue still comes from games that include the spin of a wheel, the throw of a dice or the turn of a card that they can offer their clients. Gambling can account for between 50% and 90% of their total revenues.

Games of chance

It is not strictly true to say that they are just games of chance, though. Every game that a casino offers has a built-in statistical advantage for the house. The advantage might be small….

…. But over time and the billions of bets placed by punters, the small edge should be more than enough to pay for the lavishness and opulence that often characterise casinos. Those fountains with their dancing lights and colourful lasers can cost a fair penny to build and operate.

That can help to explain why casinos are not some of the most attractive when it comes to generating a return on shareholder funds. The median return on equity is a mediocre 6.5%. It means that on average, casino operators generate only around $6.50 of profit on every $100 of shareholder money.

Inconsistent returns

But that belies the vast range of returns that these casinos exhibit. At the low end are Melco Resorts & Entertainment and MGM Resorts International with returns on equity of only a few percent. At the top end, though, Wynn Macau and MGM China have delivered strong returns of in the high double digits.

But the returns are far from consistent – they can vary widely from one year to the next. That, perhaps, underlines the fact that despite the built-in edge, luck, both for the punter and the house, can still play a big part.

That is best explained by the net profit margin for casinos. On average, they make about $9 of net profit on every $100 of turnover, which doesn’t look too bad. But the range can be vast.

At the low end, Caesars Entertainment has not made a profit in five of the last eight years of operation. Its average profit margin over that period is minus 13%. At the other end, Genting Singapore (SGX: G13), which owns Resorts World Sentosa, has been profitable every year over that period. Its net income margin is an enviable 20%.

It goes without saying that casinos can be very asset heavy. Just take a quick look at the size of Marina Bay Sands. The 20-hectare resort boasts the world’s largest atrium casino with 500 tables and 1,600 slot machines and over 2,500 hotel rooms.

When it opened in 2010, it was said to be the world’s most expensive standalone casino property. Consequently, these types of businesses require substantial revenues to keep the tills ringing.

Political risks

In the main, they don’t do too badly. They generate around $50 of revenue for every $100 of assets employed in the business, which is quite respectable. However, they can be prone to geopolitical shocks.

Between 2007 and 2012, some casinos in Macau were reporting asset turnovers in excess of two. In other words, they were generating revenues of $200 on every $100 of assets, which is four times more than the current average….

…. However, an anti-corruption crackdown by the Chinese government in 2014 frightened off many high rollers. Consequently, the asset turnover dropped almost precipitously.

Buddy can you spare a dime?

The asset turnover can be an important driver of a company’s return equity. So too can leverage, which is essentially using other people’s money through borrowings to help generate a return for shareholders.

By and large, casinos do use leverage to help boost their returns. They have around sixty times more liabilities than assets. That is understandable, given that these are expensive businesses to build.

Consequently, the use of leverage can help to boost the returns that these companies generate for shareholders by around 70%. But excessive use of leverage can expose shareholders to unforeseen risks such as economic downturns and interest rate rises.

Show me the money

Currently, the average dividend yield on casinos is an acceptable 3.3%. However, with an average payout ratio of almost 60%, and a median return on equity of 6.5%, those dividends might only grow around 2.5% a year.

That said, there is chance of some capital growth if the operators should hit it lucky by being in the right location at the right time. But in a crowded market that is getting increasingly more crowded, it is a bet that some of us might not be prepared to make.

A version of this article first appeared in The Business Times.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.