I rate Penn National Gaming (NASDAQ:PENN) a buy due to its healthy margins, undervaluation by relative and absolute metrics, and its highly-valued casino/gaming segment. PENN has had a rough start to FY22 with its share price falling by over 42% year to date. Currently, the company’s stock is about $1 above its 52-week low. PENN’s poor performance can be attributed to macroeconomic headwinds that have led to a decrease in travel spending. These headwinds have given investors a buying opportunity at a significant discount for long-term growth potential.
A dominant growth driver for PENN is the amount of travel spending in the United States. The online travel index (FCTSOTVL) tracks the daily percentage change in daily online travel spending. The index, which is illustrated in blue in the graph below, shows that there has been a significant decrease in online travel spending in FY22. The continued decrease in travel spending could become a significant headwind and negatively impact top line growth. Additionally, the green line on the graph below represents PENN’s stock price over the last five years. The graph indicates a strong positive correlation between online travel spending and PENN’s share price. Because online travel spending is down significantly, PENN’s share price is also down.
The graph below illustrates a positive correlation between online travel spending and the company’s revenue growth. This correlation is not as strong as the correlation between PENN’s share price and the online travel spending index. There was a noticeable uptick in revenue during 2021, which was attributed to the large spike in travel spending between 1Q21 and 2Q21. Over the last 5 years, PENN has experienced steady growth (excluding the 2020 outlier), but is still susceptible to the cyclical winds of travel spending.
Another growth driver is whether state governments around the U.S. continue to enact legislation to expand the legality of casino gambling and sports betting. As of May 2022, 18 states have allowed land-based commercial casinos and 27 states have allowed sports betting. Additionally, there are bills on file in four states to legalize sports gambling (see below). All four of these laws have been signed and are currently waiting to be enacted. In Maine, a bill was signed in May 2022 and is anticipated to launch in mid-2023. In Ohio, a bill was signed in December 2021 and is anticipated to launch by January 2023. Both Nebraska and Maryland have signed laws to legalize sports betting, but have not released a date for the legislation’s enactment.
PENN has very healthy margins, which will aid in further profitability of the company in the future. In FY19, PENN had 14.73% EBIT margins. In FY20, PENN had 5.98% EBIT margins. In FY21, PENN had 17.98% EBIT margins. Due to high costs of revenues (53% of revenue) and operating costs (32% of sales), PENN’s EBIT margins are noticeably thinner than its EBITDA margins.
PENN’s EBITDA margins are very healthy. In FY19, PENN had 23.84% EBITDA margins. In FY20, PENN had 19.59% EBITDA margins. In FY21, PENN had 26.54% EBITDA margins (see below). Assuming PENN limits its operating expenses, PENN’s wide EBITDA margins will make the company extremely profitable. This profitability will drive significant free cash flow for management to reward shareholders via continued stock buybacks.
Due to the economic shutdown in FY20, casino stocks especially struggled due to their reliance on revenue generated from in-person entertainment and hotel occupancy. The shutdown caused casino stocks to experience significant decreases in revenue, EBITDA, and free cash flow. In FY20, PENN’s revenue decreased by over 32%, its EBITDA decreased by 45%, and its free cash flow decreased by 167% (see below). Additionally, the shutdown caused noticeably thinner margins. In FY20, PENN’s EBIT margins decreased by 58% and its EBITDA margins decreased by 18%.
PENN’s recent earnings report revealed a balance sheet that continues to be highly leveraged. Currently, the company’s debt-to-equity ratio is 3.57x, which is worse than the YE21 ratio of 3.13x. If you are a potential investor in PENN, the large amount of total debt on its balance sheet is an area of concern, especially with the rising risk of recession by YE22.
When comparing PENN’s multiples to industry averages, it appears that the company is trading at a discount. Relative to the industry average of 18.2x, PENN’s P/E ratio of 14.7x indicates that it’s undervalued. Additionally, industry averages indicate that PENN’s EV/EBIT multiple is trading at a 72% discount (see below), while its EV/EBITDA multiple is trading at a 16% discount. And finally, PENN’s EV/Revenue is also trading at a discount of 9%.
Relative to peers, PENN’s valuation multiples indicate that it is undervalued as well. In comparison to its P/E ratio of 11.57x, the P/E ratio of direct competitors such of MGM (32.2x), CHDN (18.2x), and BALY (21.7x) all indicate that PENN is trading at a discount.
Furthermore, PENN’s EV/EBIT multiple of 14.2x is also trading notably lower than direct competitors. In comparison to PENN’s EV/EBIT multiple of 14.2x, the EV/EBIT multiple of MGM (31.7x), CHDN (15.6x), and BALY (18.7x) all indicate undervaluation (see above).
PENN’s EV/EBITDA multiple of 8.1x also indicates that it is trading at a discount. In comparison to PENN’s EV/EBITDA multiple, the EV/EBITDA multiple of MGM (11.6x), CHDN (10x), and BALY (9.1x) all indicate that PENN is trading lower than other blue-chip casino/gaming companies.
Valuation by Segment
In order to calculate the valuation of PENN’s assets, I multiplied each segment’s estimated 2022 revenue by a relative multiple of a company with similar operational assets. To value PENN’s casino/gaming assets, I calculated the EV/Revenue multiple of MGM, DKNG, PDYPY, SCPL, and WYNN (see below). After averaging these multiples, I arrived at an average EV/Revenue multiple of 3.8x. To arrive at the valuation of PENN’s food/beverage assets, I calculated and averaged the EV/Revenue multiples of CAKE, DRI, and BLMN, arriving at an average EV/Revenue multiple of 1.59x (see below).
After multiplying each segment’s estimated 2022 revenue by the average relative multiple, my valuation model indicates that PENN’s total operational assets are worth $21.8 billion, the majority of which is attributed to the casino/gaming assets. According to my model, PENN’s casino/gaming assets have a $20.2 billion valuation, while its food/beverage segment is worth $1.6 billion. After arriving at each segment’s valuation, I subtracted the value of the casino/gaming assets from PENN’s enterprise value, arriving at a valuation of -$1.7 billion (see below). This negative valuation implies that investors are not paying for the food/beverage segment, meaning that they are receiving its revenue for free.
For my discounted cash flow model, I used analyst estimates of $6.34 billion and $6.6 billion for revenue in FY22 and FY23, respectively. Furthermore, I made assumptions of an 8% CAGR for revenue in FY24 and FY25 (see above). For assumptions of expenses, CAPEX, and changes in NWC, I used three-year historical averages as a percentage of sales. After placing these assumptions into my DCF model, I arrived at the following cash flows for FY22 through FY25:
For my discount rate, I calculated PENN’s WACC to be 11.39% using its current market capitalization and current market value of debt (illustrated below). To calculate PENN’s Cost of Equity, I used the Capital Asset Pricing Model. Assuming an expected market return of 7.5%, I arrived at a market risk premium of 4.51% (see below). To calculate the market value of debt, I used PENN’s interest expense and total debt at FYE21.
After using a WACC of 11.39% to discount my forecasted cash flows, I arrived at an intrinsic value of $45.07 per share, representing 55.15% upside from the current share price (see below). My price target falls just under the median price target of $56.50 among 38 different Wall Street analysts. Twelve-month price targets among analysts vary from $38 (30.8% upside) to $80 (175.3% upside). Furthermore, the median price target of $56.50 represents 94.4% upside.
One risk of an investment in PENN is the legality of gambling in U.S. states. Slower than anticipated legislation to expand casino gambling and sports betting could hinder its top line growth. As of May 2022, four states have signed laws to legalize sports betting, which will begin to launch in January 2023.
A second risk that PENN investors must consider is the continued decrease in online travel spending. Online travel spending has been abysmal in 2022, which could indicate a lack of consumers in PENN’s casinos. Online travel spending is a major determinant of PENN’s share price performance. This lack of travel spending has brought the company’s share price down 42% year to date.
A third and final risk is the high amount of leverage on PENN’s balance sheet. The company has aggressively financed its growth with debt. If the cost of debt financing outweighs the increased income generated, share values may decline. PENN’s highly leveraged position is especially risky as we head into recession. As the economy continues to decelerate, PENN should pay off some of its debt to avoid excess interest expenses.
As our country drifts into recession, PENN is a risky investment because it is highly leveraged. However, I believe in its long-term growth prospects, specifically its digital gambling segment. This segment will continue to expand as more states continue to legalize sports betting apps. PENN may struggle in the short-run, but it does possess strong growth initiatives. Long PENN.