Gene Marcial's Stock Picks July 28, 2009, 9:45PM EST

Marcial: International Game: "A Show-Me Story"

IGT's stock has zoomed. But analysts warn the outlook for the maker of slot machines and gaming software isn't strong enough to justify its lofty share price

http://investing.businessweek.com/services/charts/chart.asp?sym=IGT&d=365&w=600&h=300

International Game Technology— 52-week price

By Gene Marcial

BW's Gene Marcial

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As the dice start to roll again in Las Vegas, some gaming companies are beginning to spot signs of a gradual recovery. Equally important, shares of some of these outfits are also coming back to life.

One is International Game Technology (IGT), the No. 1 manufacturer of slot machines, including the Mega Jackpot systems, and related gaming software that enables gambling devices to monitor and track player activity. Shares of IGT have been among the big gainers since mid-March, zooming from a 52-week low of 6.81 a share to 19 in late July.

Does this signal the start of a longer-term recovery in the stock?

Don't bet on it. While the advance of IGT (which rocketed to an all-time high of 49 early last year) in just four months is a head-turner, some analysts aren't convinced that it is sustainable and say the shares may have hit their peak for now.

"a work in progress"

"IGT isn't out of the woods," warns gaming analyst Robert A. LaFleur of Susquehanna Financial Group, who rates the stock "negative." He expects it to pull back to 12 within a year.

LaFleur emphasizes that while business conditions have stabilized for IGT, and "investor sentiment has improved surrounding the company's cost-cutting initiatives and the revamped strategic direction explained" by IGT's new CEO and president, Patti S. Hart,, the company "remains very much a work in progress." IGT, he adds, is a "show-me story."

There is more to worry about: With the company expected by LaFleur to earn just 73¢a share in 2009 (down from $1.10 in 2008), its current price-earnings ratio of 26 "seems totally out of whack with reality,"says the analyst. Although the stock's historic p-e range is 25, LaFleur believes IGT only deserves to trade at a 15 multiple, which would translate to 12 a share.

Le Fleur notes that the Standard & Poor's 500-stock index trades at 14 times next year's projected earnings. The consensus analysts' estimate is that earnings of the companies in the S&P 500-stock index will grow 26% in 2010. LaFleur estimates IGT's earnings will inch up to 79¢ a share in 2010, vs. an estimated 73¢ in 2009.

recovery in demand "elusive"

True, on July 23 IGT reported better-than-expected results for the third quarter, driven by higher sales and margins in North America. Nonetheless, a strong recovery in replacement demand for machines, which is a pivotal factor, "remains elusive," warns LaFleur. So the modest growth expectations for 2010 are not sufficient to justify a lofty 26 p-e, he says.

On the positive side, CEO Hart is focused on improving the content of IGT's gaming machines, streamlining operations, and slashing costs. Analysts also credit her with doing what she had to do to improve the company's cost structure and new product offerings. "But a lot of wood still needs to be chopped," says LaFleur, and "the macroenvironment, while not as bad as it was, is far from robust."

IGT has a "weak near-term earnings picture and faces stiff competition," says Justin T. Sebastiano, gaming analyst at investment firm Morgan Joseph. He figures the stock is fairly valued at its current levels, and rates it a hold.

IGT was unavailable for comment.

Some bulls on the stock (8 of 23 Wall Street analysts rate it a buy) argue that the company will benefit from a recovery. Indeed, gaming companies are very much dependent on a strong economy for their businesses to thrive. But there is doubt among analysts that the recovery will be robust and rapid. Ten analysts rate IGT a hold and three recommend selling the stock.

Among big institutions currently holding the stock, Capital World Investors has a 4.8% stake and T. Rowe Price (TROW) holds 4.47%.

At the same time, however, several large stakeholders have reduced their interests, including Fidelity Management, which as of Mar. 30 had unloaded 3.5 million shares; it still owns a 3% stake. As of Mar. 30 Private Capital Management has sold some 2.6 million shares, cutting its stake to 2.3%.

The stock is "ranked to be a market underperformer in the coming year," warns analyst Alan G. House of independent investment research firm Value Line (VALU). He says IGT has the potential to recover sometime between 2012 and 2014. And he cautions that earnings volatility "may be above historical levels in the near term."

Given such warnings, this may not be the best time for investors to gamble on IGT.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.