Some investors might look past Penn National Gaming (NASDAQ:PENN) at this point. After a post-earnings pop Thursday, PENN stock now has rallied nearly 400% from March lows. Meanwhile, near-term pressure from the novel coronavirus on the gaming industry seems likely to be intense.
From a long-term perspective, however, I believe that would be a mistake. I’ve recommended Penn National since it traded below $10 at the beginning of last month. At $18, I still believe the stock is a winner.
After all, we’re seeing the country, thankfully, begin the process of returning to normalcy. At some point, that will include the casino business.
Meanwhile, Penn has a huge opportunity in sports betting and online gambling. And the same heavily leveraged balance sheet that helped drive a 90% decline in a matter of weeks in March can amplify upside going forward.
Certainly, to some extent, the easy money has been made. Penn National isn’t going to gain another 384% over the next seven-plus weeks. But there’s still a path for the stock to return to, and potentially beyond, highs near $40 reached early this year.
Put another way, PENN stock has more upside left.
Unsurprisingly, brick-and-mortar casino operators have been absolutely hammered since the coronavirus began to spread.
Penn’s stock has nearly quintupled from the lows, but it is down 29% year-to-date and over 50% from its February highs. Eldorado Resorts (NASDAQ:ERI) has fared far worse, losing two-thirds of its value in 2020. Las Vegas Sands (NYSE:LVS) and Wynn Resorts (NASDAQ:WYNN), which have substantial operations in the Chinese enclave of Macau, are off 32% and 43%, respectively.
The weakness makes some sense. There’s going to be a mid-term impact on the industry. Re-opening plans, for instance, include reduced seats at blackjack tables and fewer slot machines on the gaming floor.
Even with those restrictions, many customers won’t be comfortable setting foot in casinos for some time to come.
Balance sheets amplify that pressure. Penn National closed its first quarter with $2.17 billion in debt net of cash. It pays another $900 million annually in rent to real estate investment trusts, primarily Gaming & Leisure Properties (NASDAQ:GLPI). Penn spun off GLPI back in 2013.
Put another way, the 90% decline in PENN stock didn’t reflect the market’s opinion that the business was worth 90% less. Only the equity. With over $2 billion in net debt, and lease commitments of nearly $9 billion on the balance sheet, the loss of about $2.5 billion in market capitalization from the highs perhaps makes some sense.
Sports Betting and iGaming
But Penn isn’t just a brick-and-mortar operator anymore. The company is building out its online gambling capabilities in Pennsylvania. Per this week’s first-quarter release, the company has added 40,000 customers in that state with reasonably modest marketing spend.
And, of course, earlier this year Penn acquired a 36% stake in Barstool Sports. PENN stock soared on that news, as it gave the company a hugely popular brand for its sports betting operations.
Investors are enormously optimistic about those businesses at the moment. DraftKings (NASDAQ:DKNG) has more than doubled so far this year. It has a market capitalization nearing $9 billion.
GAN Ltd (NASDAQ:GAN) just listed in the U.S. — and the stock has rallied to $13.50 from an initial public offering price of $8.50. Meanwhile, Flutter Entertainment (OTCMKTS:PDYPY), which owns FanDuel, now is roughly flat year to date.
The market is seeing U.S. sports betting, in particular, as a huge opportunity. And legalization may expand more quickly as state governments look to raise revenue. Certainly, in other stocks, investors are buying that thesis. They will likely do the same with PENN stock as well.
There are risks. But the fear in March that Penn wouldn’t make it through this crisis now seems unfounded.
Penn said in the Q1 release that it finished March with $731 million in cash. The average cash burn rate with casinos closed is about $83 million per month.
Penn can get to the end of the year even with casinos closed, but some are preparing to reopen. Meanwhile, GLPI is incentivized to keep Penn afloat. Its chief executive officer, Peter Carlino, is part of the family that founded Penn National. Carlino and family trusts still own 4.5% of PENN stock.
GLPI already made a deal with Penn to acquire the Tropicana Las Vegas. If need be, it can make more deals to provide cash to Penn or allow the operator to defer rent. The balance sheet is heavy, but fears of near-term bankruptcy fortunately seem minimal.
The Long-Term Case for PENN Stock
That leaves a solid long-term case. Penn has real drivers in iGaming and sports betting. Brick-and-mortar operations will return to normalcy at some point. The combination suggests at some point that Penn’s stock can retake its February highs.
With the stock at $18, that still suggests significant upside. Even if it takes a full five years, PENN stock would return about 17% a year. That’s a solid return. If the company is a big winner in sports betting, the returns can be even bigger.
The balance sheet that pressured the stock on the way down can amplify the gains on the way back up. Indeed, it has done so already. And while the absolute amount of debt and leases is a concern, Penn has plenty of flexibility.
The country is going to get back to normal. So will Penn. And as that happens, the bull case that investors loved in February will come back. Over time, the same will be true for the price of Penn’s stock.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.