Get The Ultimate Gaming Experience With Pinnacle Casino – Penn National Gaming, Inc. Stock Chart Turns out (NASDAQ:PENN) tells a simple story. Investors were happy about sports betting stocks in the second half of 2020 and the first half of 2021, but the results on the field (including Penn itself) were disappointing. And so PENN is down more than 60% from its highs, dragged down by significantly lower expectations for Barstool’s sports betting and online casino business:

After all, Penn’s online sports business is lagging behind in the US, as this tweet from Chris Krejcik of the respected industry research firm Eilers & Krejcik shows:

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Therefore, there is a way to look at PENN’s decline as fully deserved, with the run over $120 by retail investors and/or fans of Barstool, and the decline since then due to Barstool’s lack of success in the market so far. Looking ahead, at least in the short term, geopolitical concerns, higher interest rates and higher gas prices (historically a legitimate headwind for surface operators) pose risks. And in addition, while PENN has fallen from its peak, it has gained almost 100% since the agreement to buy 36% of Barstool Sports in January 2020.

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That story, however, missed a possible opportunity, for three important reasons. First, it understates the value of Penn’s existing ground operations, which continue to perform exceptionally well. Second, the interactive business here actually seems to be in better shape than simple market share data would suggest. Third, Penn has many options moving forward to adapt to the rapidly changing (and normalizing) world of online gambling and its impressive portfolio growth.

Given these factors and the solid fundamentals, PENN appears to be oversold from a long-term perspective. However, the current short- and medium-term risks are relatively high. Geopolitical concerns, inflation and higher interest rates pose potential obstacles and raise more structural questions about the profitability of onshore operations. Broader and simpler, PENN is a cyclical financial instrument when market and macro issues simply must be at the forefront of investment decisions.

Therefore, some patience seems to be required here. In the long run, PENN is probably a good choice. In the short term, it is not hard to believe that better prices can be achieved.

Last May, I argued that PENN stock was a solid buy for online gamblers — but raised concerns about valuation. Namely, PENN does not look cheap, almost 13x 2019 adjusted EBITDAR. (EBITDAR is earnings before interest, taxes, depreciation, amortization, and rental real estate leased from gaming and recreational property owners (GLPI). This rental expense can be capitalized and added to enterprise value to accurately calculate EV/EBITDAR. )

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But with the share price about a third lower and profits rising, the fundamentals look quite strong. Based on mid-2022 guidance, EV/EBITDAR is 9.25x. But even that is a little overblown. In the Q4 conference call, Penn management estimated ~$50 million in losses in the interactive segment (losses driven by investments in online sports betting and online casinos) this year. Make up those losses and decline many times to 9x.

Of course, that 9x figure does not include the value for online gambling. Given, say, a $3 billion valuation there (more on this valuation later) and the multiple assigned to the onshore business drops to ~7.5x. More specific guidance released at the fourth quarter conference indicates that PENN trades at ~10x 2022 free cash flow, excluding interactive losses, working capital changes and growth.

Although many may not be as attractive as they seem at first glance. Due to leverage (Penn’s net debt, including capital lease costs, is still more than 4x 2021 EBITDA) and the cycle, casino operators generally see more in this range. PENN itself was trading at ~6x EBITDAR and ~7-8x P/FCF just a few years ago.

However, PENN is still less leveraged than then: the leverage ratio of 4.1x at the end of 2021 is the lowest for the company since the GLPI spin-off. And at the very least, PENN’s price of $49 does not show consistency – and importantly, secular growth – progress, as it does at $100 and above. Here, the worst-case forecast is very reasonable, although the forecast is not as interesting as it seems to be related to the market.

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Metrics 2022E* 2021A 2019A ’22 vs. ’19 Net Income $6,230M $5,905M $5,301M +17.5% Adjusted EBITDAR $1,900M $1,994M $1,605M $5,905M +18.5% Interactive $18.00*3% -$50M -$35M +$12M N/A Rev Ex-Interactive $5,580M $5,580 472M $5, 263M +6.0% AE Ex-Interactive $1, 950M $2, 029M $1 , 593M +22.4% AE margin. 34.9% 37.1% 30.3% +460 bps Click to enlarge

But comparing 2019 to 2022 also shows the biggest problem with the business on shore. Penn estimates it will grow adjusted EBITDAR at a ~7% annual clip over three years — an impressive performance given the lingering effects of the novel coronavirus outbreak here in early 2022. As executives noted on the fourth quarter call, older users seem to be the most cautious about returning to casinos, and those who tend to focus on slots tend to offer the best margins.

However, the performance is mainly due to the increase in profit margin. Penn expects an asset-grade margin of 37% in 2022, which represents an increase of about 500 basis points from 2019 levels, according to the 4Q call.

That’s a big change. And the concern not only for Penn, but for the industry as well, is that sustainable growth. Of course, some sponsors have used federal gambling stimulus money (if not directly, then indirectly) in recent years; We have seen this activity in the stock market. (See, for example, the explosion in the volume of options in the broker Robinhood (HOOD).) Leverage operating in the casino model means that incrementally spending per visit generally decreases almost cleanly to the bottom line, the margin increases. (There is absolutely no difference in the cost of serving a blackjack player who bets $15 per hand versus someone who bets $25.)

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The promotional environment remains soft, as detailed by Penn management in the fourth quarter call. (Caesars Entertainment (CZR) Chief Executive Tom Reeg, in his company call, similarly said that his company doesn’t see “anything to call” in the proposition for clients.)

The concern, therefore, is that the 2022 recommendation means something closer to the upper limit. Regional operators have been reducing promotions for about a decade now – and margins across the board have increased as a result. US consumers remain ready and willing to spend. Flash back to 2014, the first full year after the spin-off, and Penn produced a combined EBITDAR margin of 27.3%. Guidance for 2022, excluding interactive losses, indicates a growth of 400 bps. The size of Pinnacle’s acquisition certainly helped, but it seems at least that margin expansion will be difficult from now on.

Now, to be fair, these concerns have been around for a while. I will personally accept the loss of profits in the sector due to concerns about margins and higher valuations before the iGaming driven rollers enter the universe. But these risks at least prevent the valuation given to the company in the area seems necessary

Of course, there are external risks. Broadly speaking, despite the low valuation and downside, PENN still has significant macro exposure. Owning PENN now also means owning cyclical leverage at a time of high geographic and economic risk. The economy can turn south. Rising gas prices are a real risk (price increases in the middle of the last decade affected casino attendance, at least according to executives at the time; Penn called lower fuel prices in 2015).

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This is hardly a hidden risk – but that’s the point. At a time when the stock market is clearly bullish, there are real questions about its effectiveness. affect the cycle

. In fact, PENN fell almost 5% on Thursday. (Disappointing earnings from Rush Street Interactive (RSI) may have been a factor, though.)

At the same time, it is difficult to see a clear trigger in the near future. First quarter earnings in late April or early May are unlikely to change much on either side of the business. Penn has some room for mergers and acquisitions (more on that in a bit), but this is not an environment for dynamic deals, from a buyer’s or seller’s perspective.

There is another risk issue here: there may be better options for buying risky stocks that are far from their highs. Many names that once grew popular in other sectors (electric vehicles, SaaS, etc.) that decline are certainly high risks because some of those names will go to zero. But even in the space, Wall Street analysts see more growth in CZR and DraftKings (DKNG), among other names.

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There is certainly a lot to like about PENN stock. But investors must take into account the risk, whether in the long term, medium term

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