THE HEDGEYE EDGE
Yes, you read that right. We are getting positive on a regional gaming stock. You’ve heard our negative demographic call for a while and we’ve correctly predicted mostly disappointing monthly state revenues for the past quarters.
So what exactly has changed?
- Shares of Penn National Gaming have been brutalized over the last 6 months, and are trading close to 6.6x EV/EBITDAR.
- The fundamentals appear stronger. Regional gaming appears to be picking up in Q4 – whether it’s improving consumer confidence from the election, we’re not sure yet.
- Finally, we wouldn’t be surprised to see the company’s first buyback as free cash flow is accelerating and the stock valuation suggests pretty good accretion.
INTERMEDIATE TERM (TREND)
We recently attended the investor event at the newly opened Hollywood Jamul casino near San Diego. While the event was informal, and management didn’t make any announcements, we sensed some optimism regarding regional gaming which synchs with what we’ve been hearing elsewhere.
The Jamul property looks good and seems to be doing well which obviously gives us comfort in our estimates for the new property. Management seemed particularly pleased with the performance of its Las Vegas and Ohio properties.
If regional gaming stabilizes and, dare we say, begins to grow again, we think management would be foolish not to pursue a stock buyback program, particularly with free cash flow accelerating and the stock trading at a relatively cheap valuation.
Across our duration 3-6 months here is some more detail on the top three things to consider.
- Regional gaming might be improving – We were already projecting sequentially accelerating improvement from October but there seems to be a new level of optimism in regional gaming. We’ll see over the next few weeks as the states release gaming revenues whether our forecast proves too conservative. We think it will. Looking ahead, our contacts are now expecting some growth. Positive same store EBITDA growth next year would probably surprise some investors. Following our meeting with management, we now feel there is actually some opportunities for cost cutting so even in a flat revenue environment, EBITDA could grow. PENN has run a pretty lean operation for a few years so we hadn’t expected even more cost saving initiatives.
- Capital return makes sense right now – Despite sluggish regional gaming revenues this year, PENN finds itself in a good position to start returning cash to shareholders. With only maintenance capex, 2017 will be a year of cash harvesting. A dividend is possible, but with the stock down here, a buyback program makes much more sense and would be a bigger catalyst for the stock, in our opinion.
- Cheap valuation – PENN was down 19% this year and 26% off its 52 week high (when we added it to the best Ideas List on 12/2/2016). The stock trades at ~6.6x 2017 EV/EBITDAR (it's even lower on an EV/EBITDA basis). At this level, it won’t take much in the way of positive catalysts to move the stock. We think those catalysts are in place.
LONG TERM (TAIL)
We remain negative on the long term demographic picture for regional gaming. Generations below Baby Boomers do not appear to be interested in playing slot machines. However, macro can overtake demographics for periods of time.
With the Hedgeye macro team is signaling a brighter outlook for domestic consumption, regional gaming revenue growth can accelerate in 2017. With cost cutting opportunities still available to an adept management team, EBITDA growth looks increasingly likely next year.
ONE-YEAR TRAILING CHART
