Even as Penn National Gaming Stock Rebounds, Consider Other Casino Plays

Friday 8th May 2020

[Editor's Note: "Even as Penn National Gaming Stock Rebounds, Consider Other Casino Plays" was originally published April 17, 2020. It is regularly updated to include the most relevant information.]

Should you buy Penn National Gaming (NASDAQ:PENN) stock? Shares have rebounded in recent weeks, as investors shake off novel coronavirus concerns, and look to a rebound for the gaming operator. But don't assume this means the company is out of the woods just yet. It could be a while before casino operators "return to normal."

Casino stocks offer high risk, but high potential returns. Yet, Penn National may not be your best option. Firstly, the company mostly leases the real estate under its casinos. This may have been a smart financial engineering move. But it leaves them fewer liquidity options relative to peers.

Secondly, shares trade at a valuation similar to that of Las Vegas Sands (NYSE:LVS). Other big players, like MGM Resorts (NYSE:MGM), and Wynn Resorts (NASDAQ:WYNN) may trade at higher multiples. But their strength relative to Penn may justify this premium. This could make them better ways to play a potential industry rebound, as might VanEck Vectors Gaming ETF (NASDAQ:BJK), which holds all four names in its 42-stock exchange-traded fund portfolio.

Also, who knows if the gaming industry will fully recover once the pandemic fades? Given the high-fixed costs of the gaming industry, even a 20% decline in revenue could mean bad news. Especially for weaker names like Penn National.

Considering these factors, other casino stocks may offer better opportunity. Let's dive in, and see why PENN stock isn't your "best bet."

Can Penn National survive the coronavirus? When the pandemic first hit America, Wall Street's answer was a resounding "no" as shares fell from above $39 in February to as low as $3.75 in March. Yet, with states starting to allow limited reopenings of casinos, shares have rebounded four-fold, and now trade around $15 per share.

Will shares continue to climb? That depends. Until we know when casinos are going to re-open, handicapping this stock remains a game of "predicting the unpredictable."

But, there's another big risk specific to PENN stock. The company, leases, not owns, most of its properties. In fact, the company was a pioneer in the casino REIT (real estate investment trust) trend.

In 2013, the company spun off most of its real estate as the first casino REIT, Gaming and Leisure Properties (NASDAQ:GLPI). This transaction allowed them to realize the underlying value of its property. But while this boosted valuation, it left them exposed to heavy lease liabilities.

As our own Matt McCall wrote on April 3, Penn National carries $8.5 billion in lease liabilities on its balance sheet. In 2020 alone, the company must make $900 million in lease payments. This wouldn't be a problem if their casinos were generating cash flow. But how about now, when its casinos are sitting idle?

Yet, the stock's current valuation doesn't reflect this weakness. In fact, shares now trade at a valuation on par with peers.

The recent rally in PENN Stock has made shares richly priced. The company's enterprise value/EBITDA (EV/EBITDA) ratio now stands at 11.2. That's on par with the multiples of stronger players like Las Vegas Sands. Granted, other larger rivals like MGM and Wynn now trade at higher EBITDA multiples. But, this company is on shakier ground financially.

According to Morningstar's Dan Wasiolek, Las Vegas Sands has enough liquidity to operate up to 18 months with near-zero revenue generation. On the other hand, Penn National only has about nine months worth of liquidity (based on monthly cash burn).

However, because most of Penn's liabilities are leases with GLPI, the company could see some rent relief. The spun-off REIT entity has already helped out its former parent, agreeing to buy several properties in exchange for $337.5 million in rent credits.

Rumors of casino re-openings has reignited interest in Penn National. The recent surge in its share price reflects this. Yet, that doesn't mean shares are a screaming buy at today's prices.

As I highlighted last month, other opportunities could offer a better risk/return proposition. PENN stock? Not so much. In short, this isn't your "best bet" on a casino industry rebound.