PENN isn’t the cheapest stock we’ve ever seen but on a relative basis, the valuation doesn’t seem to make much sense. So what’s the explanation?
In an era when debt is considered a liability (no pun intended), one would think that PENN’s low leverage would be rewarded. Looking at its EV/EBITDA multiple, it is clearly not. PENN trades at under 7x 2011 EBITDA, slightly below the peer group average. We’ve seen regional gaming stocks trade down to 6x EBITDA, so there is precedent for downside. However, EBITDA is depressed and PENN’s story is much more compelling than the stocks we’ve seen trade at 6x. Moreover, compared with other regional gaming operators, PENN maintains much more positive investment attributes:
- Best management among the regionals and maybe all of gaming – history and commitment to ROI
- Best balance sheet among all operators
- More growth – more development opportunities
- Self-funded growth – leverage stays around 2x during the construction phase of Columbus, Toledo, and Cecil County
- Growth mostly in new markets – much higher ROI than building in an existing market
So what gives? I guess PENN is not the most exciting story over the near term but neither are any of the other regionals. Unless you are expecting a sharp recovery in regional gaming revenue which would benefit the earnings of highly leveraged companies disproportionately. In this uncertain environment, investors seem afraid of capital driven growth and the perception is that PENN will be levering up to drive investments in risky projects. Other than PNK and its Baton Rouge project, PENN is the only company investing in new casinos. There is also acquisition risk. PENN maintains a ton of liquidity to buy assets or companies and, again, investors may not want to see capital put at risk.
- Growth fueled by investment spend - people may want to play recovery growth
- Exposure to additional supply – Lawrenceburg will be hit hard by a new casino in Cincinnati but the net Columbus/Toledo/Lawrenceburg should still be high ROI
- Acquisition risk
We recognize PENN isn’t the most non-consensus call on the sell side. Most analysts have buy ratings. However, even a broken clock is right twice a day. Downside appears limited – numbers look better than they did when the stock fell through $23 – and we think the sell side may have this one right.