The Rally In Penn National Gaming Has Another 35% Potential

There is life after Covid-19 for gaming stocks like PENN

Covid-19 caused tremendous human tragedy and it also decimated millions of businesses worldwide. The quarantine was especially harsh on the hospitality and entertainment industries. Many gaming stocks like Penn National Gaming (NASDAQ:PENN) lost 75% or more of their value. But this not their first time facing difficulties, so management teams are smart enough to handle the recovery. PENN stock has already rallied 450% off the worst of the March 20 low, but not before losing 92% of its stock price in this fall from grace.

Image of The M REsport: The Rally In Penn National Gaming Has Another 35% Potential
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This happened in only four weeks, so Wall Street completely panicked. Today we evaluate the upside opportunity as the world goes back to work.

The bounce off the bottom clearly proves that there still is an appetite to buy these stocks, but the easy path may be already over. When a stock falls far then recovers halfway back, it usually hits resistance. PENN stock is at this juncture now so I expect it to face some sellers near $20 per share. The good news is that the bulls have been setting higher lows. All they need is a little dip to build better conviction so they can battle the bears above.

So Far so Good for PENN Stock

PENN Stock Chart
Source: Charts by TradingView

Last week, management reported earnings and investors liked what they saw. It also helped that they raised $600 million from equity and bond issues. They are ready to face the next few months with a stronger balance sheet, and they will need every bit of it. More on this later.

So far, the positive reaction around the earnings has held, and investors are testing the breakout neckline for footing. As long as PENN stock stays above $14 per share then the bulls retain control. This way they can maintain the higher-low trend as they recover more levels that they lost in the last two months.

One very important line is at $20 per share, as it marked the fail from Monday. But this has been a battleground spot since January of 2015 (see chart). I bet that if they break through they can rally to $30 per share. There will be resistances at the $23, $25 and $28. When a stock approaches a level that has this much history it is normal that it fails at its first breakout effort. It may even take a few tries.

Eventually the bulls will prevail, but they are not likely to recover the highs. They say that “somewhere in the middle lies the truth” and in this case the rally to $40 and the fall to $4 were both outlier extremes. Investors need to be realistic with their bullish expectations. Those who own the stock can probably sit through the rest of this virus crisis as states continue to reopen. But those looking for an easy rally need to temper their enthusiasm. Because even if we reopen today, the new normal is not back to what was normal.

There Are Big Potential Problems Coming

Investors would do well to book profits near $22 and $25 per share. I expect the rally to take a hit from a big dose of reality. There is a lot of talk of restricting capacities, which will severely impact operations. Penn National will not be able to pack its floors like before, so there will be major downside adjustments. MGM Resorts (NYSE:MGM) this week announced that it is reopening its Las Vegas facilities at only 25% capacity.

While some income is better than none, it’s a far cry from normal. There is a breakeven point and I doubt that it is below 50%. Selling only a quarter of the rooms is not likely enough to pay for the costs to run it.

Investors have to accept that the regulatory risk is real because governments in North America may force similar restriction on everyone. Penn National may need to forever modify their business model. They will probably raise prices and renegotiate contracts from rents to advertising budgets. I can’t imagine that their convention business will relaunch anytime soon. This will be a very messy process so the hard work is just starting.

So far Wall street is giving them the benefit of the doubt because they are working on alliances like the one with Barstool Sports. But they are not out of the woods.

Options Offer a Better Twist on the Buy and Hold

One way to capitalize on the high levels of volatility in the markets is to use options — sell puts or put spreads below support. This creates the opportunity to profit from the strength in PENN without needing rallies.

For example if an investor is looking to buy the stock at $18 per share, they can alternatively sell the $10 January put and collect $2.20 per contract today. As long as the stock stays above $10 they are complete winners with no money out of pocket. Otherwise they own the shares and their break-even is $7.80.

It is unfair to judge the fundamental because, as we said, there will be a new normal. I personally hope that the authorities do not force Covid-19 changes on an ongoing basis because the negative repercussions will be hindrances forever. It is important to note that the government is spending trillions of dollars to spur the economy, but I am a skeptic that it will have the impact they hope. The stimulus check are not going to help PENN because there’s no incentive to socialize. In fact there is the exact opposite of it, so I fail to see how the bailout is going to pack the casino or racetrack floors.

Cautious optimism is an appropriate term in this case, and the best way to actually implement that is using the options markets.

Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room for free here.


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