Hurricane Katrina wrecked the Gulf Coast and gaming stocks. But with a blowout earnings report, Harrah's is no longer down on its luck.

Investors who bet against the gaming companies after Hurricane Katrina wrecked Gulf Coast casinos have been on a roll, as the stocks are down an average of 18.5% since the storm. But that game may have just changed. And as Kenny Rogers would remind us, you've got to know when to walk away, and when to run.

After Harrah’s Entertainment’s (HET, news, msgs) third-quarter earnings report this morning, it looks like a good time to run. Harrah’s posted third-quarter earnings per share of 91 cents, which was well below last year’s gain of $1.06 per share. It should be noted, though, that the current-year figure was diluted by the addition of 67 million shares used to help fund the Caesars acquisition in June. Excluding special items, Harrah’s gained $1.05 per share or three cents better than the Street expected. With the hurricanes and high energy prices, that's a great number.

Despite a jump of 78%, the company’s revenues of $2.3 billion fell a bit shy of Street estimates. Revenues were strongest in Las Vegas (up 10.2%) and understandably weak in the Gulf states (down 13.3%). Overall, hotels and casinos opened at least a year posted a gain of 3.8%. Not eye-popping but, in light of the macro-conditions, good enough to alter the prevailing bearish sentiment.

A full-hand of positives
And sentiment, more than anything, was responsible for casino stocks' tumble. Unsure of exactly how severe or how long lasting the affects of Katrina would be, investors simply folded their cards. Maybe that was the prudent course of action, but it disregarded some strong bullish undercurrents.

First, the gaming industry continues to enjoy solid double-digit growth; and quite frankly, folks, that just isn’t easy to find these days. Second, expansion in Asia suggests that the good times will continue to roll for at least a few years. Third, with more and more U.S. states suffering budget deficits, a growing number of states are likely to turn to gaming as a partial solution to their fiscal woes. Fourth, insurance covered most of the losses in the Gulf, and when the companies rebuild they will have newer, more efficient properties built in better locations. Finally, recent consolidation has created a handful of powerhouse gaming companies with unprecedented leverage -- and Harrah’s is arguably top dog.

Thanks to the knee-jerk reaction of many investors to Katrina, Harrah’s -- one the best-managed casino companies, with a rock-solid balance sheet -- currently trades at 16 times projected fiscal-year 2006 earnings. Revenues next year are estimated to climb by nearly 28% as the company enjoys the full affect of its Caesars acquisition. Not only does this make Harrah’s cheap relative to the market and its peers, but the stock has traditionally traded north of 20 times earnings. By simply returning to a multiple of 20 times estimated earnings, the stock has upside to the 80 area, or 26% above current levels.

Don't bet against Vegas
Are there still concerns about the company’s near-term future? Sure. Analysts still don’t know exactly how the combination of rising interest rates and higher energy prices will impact travel and tourism. So far, the impact has been less than feared, and that leaves open the possibility of additional upside surprises. If that changes and consumers finally do rein in discretionary spending, then we could see Harrah’s forced to lower its guidance.

There are also concerns that travelers are tiring of Vegas and that occupancy rates are about to start a downward trend. Maybe, maybe not -- I for one have seen no tangible evidence to support such a view. What I do know is that betting against the casino companies in Vegas has been a bad bet for several years now, and being out in front on this bet could prove very costly -- especially as tourists that normally visit the Gulf region look for alternative destinations.

Finally, there are still legitimate concerns that the costs associated with Katrina will be higher than expected and that the rebuild will take longer -- meaning reduced revenues going forward. Though legitimate, what usually happens in situations like these is that investors overreact and assume the worst.

In sum, today’s report from Harrah’s should go a long way in dispelling the notion that the casino industry has crapped out. With the Street forced to rethink its bearish sentiment, the stocks -- beaten up badly in recent weeks -- are poised for a nice year-end move to the upside. Harrah’s, trading near its lows and at a deep discount to industry valuations, is especially attractive.