JUNE 23, 2003
FOCUS STOCK
By Thomas Graves
At Harrah's, Good Odds for Investors | This geographically diversified casino operator gets S&P's highest rating, thanks to strong performance and an undervalued stock
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We at Standard & Poor's think Harrah's Entertainment (HET ) remains the best bet in the casino industry. We look for this stock to benefit from its attractive valuation relative to Harrah's industry peers -- and from the gaming company's expected ability to generate free cash flow that can be used to pay down debt, repurchase common stock, invest in a joint venture or acquisition, or initiate a cash dividend. The stock carries Standard & Poor's highest investment recommendation of 5 STARS, or strong buy.
Through both internal growth and a series of acquisitions, Harrah's has become the most geographically diversified casino company in North America. It operates or has ownership interests in about 26 gaming properties, including seven in Nevada and two in Atlantic City. In 2002, we believe Harrah's $3.7 billion in casino winnings was first among publicly owned companies, followed by $3.3 billion for Park Place Entertainment (PPE ) and $2.2 billion for MGM Mirage (MGG ).
In southern Nevada, the company operates Harrah's Las Vegas, Rio, and Harrah's Laughlin. Revenue and operating profit in 2002 from this region was $824 million and $133 million, respectively. (Operating profit figures discussed here include depreciation and amortization charges, but exclude certain nonrecurring items, such as project opening costs.)
FLOATING GAMES. In northern Nevada, operations include Harrah's Reno, Harrah's Lake Tahoe, Harveys Lake Tahoe, and Bill's Lake Tahoe Casino. Another gaming property, Harveys Wagon Wheel in Central City, Colo., was recently sold. Revenue and profit in 2002 from northern Nevada and Colorado totaled $441 million and $68 million, respectively.
In Atlantic City, the company operates casino-hotels under the Harrah's and Showboat names. Revenue and profit in 2002 from the New Jersey properties totaled $778 million and $217 million, respectively.
Harrah's also operates casinos on boats or barges in locations that include Joliet and Metropolis, Ill., Vicksburg and Tunica, Miss., Lake Charles and Shreveport, La., North Kansas City, Mo., Maryland Heights, Mo., and East Chicago, Ind. It has a joint-venture partner in at least one of these projects, and some include at least two Harrah's casinos.
CASH-BACK COUPONS. In addition, Harrah's now has a 100%-ownership interest in and manages a land-based New Orleans casino that opened in 1999. In 2002, Harrah's had consolidated revenue and profit from casino-boat (or -barge) projects, plus the New Orleans casino and an Iowa dog-racing facility, of $2 billion and $398 million, respectively.
In addition to owning casinos and hotels, Harrah's is represented in the growing business of gaming facilities operating on Native American land. It manages such casinos in North Carolina, Arizona, California, and Kansas. And Harrah's recently entered a new segment, "racino" gaming, as its majority-owned Louisiana Downs racetrack has added slot machines.
We expect Harray's competitive position to be enhanced by its customer reward program, Total Rewards, in which customers get cash and other offers in the form of mailed coupons that are redeemable on a subsequent visit to a Harrah's property.
BIGGER TAX BITE? In 2003, excluding pre-opening costs for new facilities and unusual items, we estimate that Harrah's net income will reach $314 million ($2.88 a share), and we project noncash depreciation and amortization at $322 million. We look for capital spending to total about $425 million, with roughly 50% of this being used to maintain existing facilities and the remainder for growth initiatives and implementing coinless slot machines.
After all capital spending, we look for Harrah's to produce close to $210 million of free cash flow in 2003 (approximately $1.95 a share), and we expect that some of it will be used for debt reduction and stock repurchases. We project earnings per share of $2.90 in 2004, rising to $3.23 in 2005, and look for free cash flow to exceed $200 million in both years. If Harrah's were to sharply reduce its new construction spending, annual free cash flow could top $300 million.
In both the second half of 2003 and in 2004, we expect growth in earnings and cash flow to be limited by higher taxes on casino winnings. In Illinois, where Harrah's has a casino in Joliet, the legislature recently approved higher tax rates that are expected to go into effect on July 1, 2003. We look for the higher Illinois taxes (including an increased admission tax) to cost Harrah's about 16 cents a share in 2003 and 30 cents in 2004.
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