Two months ago, Penn National Gaming (NASDAQ:PENN) was trading at or near an all-time high of $39.18. Today, PENN stock is 66% off that February high.
Covid-19 might be crushing leisure stocks such as Penn but a 66% haircut seems quite extreme for one of America’s best-positioned domestic casino operators.
If you’re an aggressive investor, Penn is worth considering. Here’s why.
How’s Penn’s Financial Position?
The one thing that’s become standard operating procedure for public companies during Covid-19 is to keep investors up-to-speed on what they’re doing to bolster their finances to survive the severe downturn in revenue.
There was a time when business leaders hated the idea of debt on the balance sheet. Up until 1982, share repurchases were illegal because the Securities and Exchange Commission considered them a form of stock manipulation. Then President Ronald Reagan made them legal and fiscal responsibility went out the window.
In recent years, no one has gotten richer than private equity firms, who use debt to leverage the returns for their investors.
“Private-equity firms typically double the amount of debt relative to profits on a company’s balance sheet. One of the key principles behind private equity is that increased leverage—aka more debt—can make a business function more efficiently,” Vanity Fair contributor Bethany McLean stated April 9.
“So the era of low interest rates, which began with former Federal Reserve chairman Alan Greenspan and continues to this day, has been a huge boon to private-equity firms.”
What does this have to do with Penn? In an era of low interest rates, debt’s been able to hide a lot of operational and financial sins of public companies.
In Penn’s case, a look at its 2019 10-K shows that it had just $2.32 billion in long-term debt outstanding, or 125% of shareholder equity. However, when compared to MGM Resorts (NYSE:MGM), which has net long-term debt of $11.2 billion, or 88% of its shareholder equity, Penn’s balance sheet isn’t looking nearly as attractive.
Further, if you add in all of Penn’s long-term obligations including future rent payments for leases it holds on its various casinos, you’re looking at a debt-to-equity ratio of 6.1 times. Do the same for MGM and you get a multiple of just two-times equity, one-third the smaller company.
In 2020, MGM has a total return of -60% through April 22. This compares to a -49% total return for PENN stock. By every valuation metric, MGM is cheaper or as cheap as Penn despite having a stronger balance sheet.
MGM Resorts Is a Better Buy Than PENN Stock
InvestorPlace contributor Thomas Niel recently pointed out that Wynn Resorts (NASDAQ:WYNN), Las Vegas Sands (NYSE:LVS), and MGM all have much greater liquidity to survive the Covid-19 downturn. Meanwhile, Penn might only be able to hang on for two or three quarters.
Niel goes on to suggest that Penn does have an ace up its sleeve in the form of Gaming and Leisure Properties (NASDAQ:GLPI), the company’s former real estate division that it spun off in 2013.
On March 27, its former stablemate agreed to buy Penn’s Tropicana Las Vegas real estate and the land under the casino operator’s Morgantown, Pennsylvania, casino development, in return for $337.5 million in rent credits, reducing the pressure Penn faces to meet future rent obligations.
Although Penn does have a good working relationship with GLPI, it does run a business beholden to its group of shareholders. Should Penn’s financial position worsen over the next three to six months, I doubt they’ll be nearly as accommodating about Penn’s rent woes.
Interestingly, Penn and MGM currently trade around the same share price between $13 and $14. However, MGM’s market capitalization is four times as large at $6.5 billion. Yet its enterprise value of $19.9 billion is just four-times earnings before interest, taxes, depreciation and amortization, compared to an enterprise value of $12.5 billion for Penn, or 12.1-times EBITDA.
As my colleague suggests, PENN is not the “best bet” of the casino operators. If I were forced to bet $1,000 on Penn or MGM, my money would be on the latter.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
