Penn National Gaming: The real value lies in its casinos (NASDAQ: PENN)

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“It’s getting late…early…” – Yogi Berra, New York Yankees sage

Let’s start by saying, yes, we’ll take the L on our last call of this stock on January 9, when it was $46.97. At the time of writing, Penn was trading at $36.55 today. And if news since then had been hard evidence of real weakness in consumer metrics, operational errors or a macro event like a massive wave of covid, i could well understand the decline that neither me nor anyone from other at the time could not see. But looking at the company, its fundamentals and its results since then, I see nothing at all that anyone can reasonably point to as a real reason why the stock dropped our call.

PENN Price Chart
Data by YCharts

So what I have to conclude is that the drop came from the collateral damage that swept through the entire sports betting sub-industry as well as general nervousness that was exacerbated by the usual suspects. Add inflation, Fed nerves, the war in Ukraine, gas prices, to the perception that pandemic stimulus checks have inflated gaming at most regional casinos across the country.

Where I erred was in hooking my advice on a very positive stream of information I was getting from my many colleagues working at various Penn properties. In short, the general comment was best summed up by a slot manager who told me, “We’re starting to see older people arriving feeling safe enough where they haven’t been until now. ” This is a power factor for the slot industry in most scenarios.

So that was my bullish take on my usually prescient sources in the field, against the nervous Mr. Market who saw no solace in my assertion that the cavalry was on the way.

The hawkish comments from Fed officials signaling a sharp acceleration in rate hikes are certainly fueling the nerves of many investors. That alone triggered some of the growing bearish outlook on consumer discretionary stocks. The market historically views leisure spending as one of the first casualties of Fed hikes and fears of the edge of a coming recession. However, I think for Penn, a lot of the decline is also due to profit taking given the joy the stock has had in 2021, taking it to $115 at the start of 21.

united states map

Google

Above: Penn’s geography matters, especially in areas where covid is rapidly moving toward the lowest levels of contagion since the outbreak.

Stimulus check theory? I don’t buy it. Have any of them appeared in regional casinos? Yes, but barely enough to trigger a powerful revenue boost on their own. Stimulus checks aimed at older demographics have done very little for casinos in general. The older and more vulnerable segment of the population was clearly the most absent from casinos at the height of the pandemic.

And even today, without a mass stimulus, the elderly are beginning to reappear. Slot machine win statistics, according to my colleagues from the 9 casino markets we checked, reflect the beginnings of the seniors’ comeback, not the end. The bears’ implication is that the old people came, popped their checks at the slot machines, and left. There was part of that for sure.

But it was the absence, not the presence, of the old demo that suppressed gambling winnings during the worst 18 months of the pandemic. And it is now their growing confidence in unmasking, voiding warrants and releasing pent-up demand that we will see at the properties of operators like Penn National. As these numbers rise, look for a strong trend reversal in EBITDA numbers for companies like Penn National.

So if I was wrong, like I said, I’ll take the L-but I’m still a fan of this stock. In my opinion, the action is cheap in the scenarios I offered then and now. My thesis here is that the forward thrust of the earnings recovery that I see coming is bigger and faster with the decline in equity trading.

So the strategy that I like here – agree or disagree, I understand both – is to average the prices. If, for example, you entered Penn that day – not on my advice, but on your own total rune reading on the stock at $46 – why not take the opportunity here to buy on this drop to $37 and the average price your holding at $41? In my world, you would be positioned for the upside I see over the next two quarters of about 18%.

PENN's marketing approach

Penn archives

As indicated by Yogi’s quote at the top of this article, it’s getting closer to decision time to secure strong returns on Penn being safe and plentiful for investors. We are at the dawn of a pent-up demand for recreation and games that is unleashed. This is clearly seen by incredibly jammed flights – Delta had an all-time record quarter. Hotels selling rooms at preferential rates are occupied by more than 90 people. Restaurants in major tourist destinations are packed.

Regional casinos impose the lowest decision burden on consumers coming out of statewide covid mandates. These are places where most customers can drive to within short and tolerable time frames. So far, our colleagues don’t see soaring gas prices as insurmountable hurdles and properties are balancing that cost with highly targeted promotions.

Right now, we’re looking at the late spring and summer travels and evolving ends of the covid mandate across the land state geography of casinos in all parts of the country. We’ve already seen record wins and occupancy levels block arrivals in Las Vegas side by side. So what I’m anticipating here are consecutive quarters of strong revenue and EBITDA gains ahead for Penn that should eventually bring the stock back into an arc of recovery.

Brick and mortar fundamentals are safe, but valuing Penn for sports betting is totally a fool’s errand

We have maintained, and continue to maintain, that the only sensible way for investors to value Penn is by the performance of its 44 brick-and-mortar casino properties. Trading in the stock since Penn bought Barstool Sports in early 2020 has been a rocket ship on the back of expectations for the company’s entry into the digital game. To be frank, in our opinion, this was pushed by a steady stream of exuberant management statements noting a strategic pivot of the company.

For usually very smart management, I thought this rhetoric was overheated. It was part of the growing optimism, if not frenzy, that accompanied the explosion of sports betting legalizations and revenue spikes from 2020 onwards. The pandemic has played its nefarious role here too. Players who, like everyone else, were locked down by covid, have turned to online gaming to quench their thirst for action while casinos are closed. A general false impression that brick-and-mortar casino games were time-stamped for the disaster engulfed the industry. Unfortunately, numerous statements from Penn management since their deal with Barstool have reinforced the idea that casino gaming was at a turning point and its future would be bleak compared to a sunny mountain of digital gambling. And that’s why we’ve seen the industry skyrocket for the entire sports betting sub-industry. And that’s why the real value of companies like Penn got lost in the miasma of thinking that online gaming wasn’t just part of the industry’s future, but actually BEEN the future of the sector. Some analysts predicted a company hitting $115 billion in revenue by 2027. It went wild and the inevitable bite of reality kicked in, pushing valuations back to a more logical range this year.

Added Penn National bar stool

Google

Above: The Barstool database is great but may be overstated when it comes to gaming value. But Penn’s deal made sense as they acquired a massive database relatively cheap compared to frantic after-the-fact lawsuits .

That’s not to say that online gaming and sports betting won’t continue to grow in revenue, or that Penn, most likely gaining a modest market share in the future – we estimate around 6% of a $25 billion by 2025. That would put its Barstool Sports vertical at around $1.5 billion in sales (US and Canada) added to a very possible $7 billion for its brick-and-mortar business. Penn has already decided that it will not join the massive hunt for giveaways to win new sports bettors for its platform. Yes, he remains competitive on bids, but also controls spending enough to give us confidence that his Barstool Sports unit may become profitable by 3Q22. This should be good news for shareholders going forward.

Penn’s case at $36.55 is very compelling in our view now that the way forward on Mr. Market’s sentiment looks a bit clearer than it did when I last posted on the stock.

Shares are down 13.3% over the past 90 days, reflecting what I believe is unwarranted bearish sentiment that has seeped into profit taking and overall negativity in the sector. Yet quarterly revenue growth (y/y) is up 53%.

Our 2022 revenue estimate is $6.4 billion, our earnings outlook estimates that Penn could earn between $2.45 and $2.95 per share primarily on gains from the later quarters of the upcoming pandemic.

PENN Average % of revenue generated during each quarter

Penn Archives

Above: Penn’s progress through pre-pandemic 2019

Penn’s total debt (mrq) stands at $11.61 billion, which translates to a comfortable current ratio of 1.96.

Cash (mrq) $1.86

We estimate 2022 revenue at $6.4 billion assuming a faster ramp-up than analysts expected.

The analysts’ 1-year target is $62.59 with a majority BUY.

Working from our industry sources as well as our own proprietary metrics, I’m comfortable with a 1-year PT of $72. I believe the market will begin to see through the delusions of grandeur in sports betting and begin to view Penn as both a solid brick-and-mortar operator and a viable digital presence for sports betting. It won’t be a revenue leader in the sub-sector, but it will likely start making money much faster than most.

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