Just over a month ago, I wrote that Penn National Gaming (NASDAQ:PENN) offered good value for patient investors. Since then, PENN stock has doubled from just under $16 to over $32 per share. Despite the scale of that rally, there’s still plenty of room left to run.
Penn National Gaming is normally a profitable casino company. It also has a 36% stake in Barstool Sports, a sports betting app and website. It can buy 50% control in three years for $62 million. I believe the market is probably giving a lot of credence to the potential profits from that relationship.
For example, everyone has seen how fast and high DraftKings (NASDAQ:DKNG) stock has risen since its effective reverse-merger IPO. DKNG stock has skyrocketed since late April.
I suspect that ebullience on sports betting and the “i-casino” effect is what may be driving a good part of PENN stock’s recent move up.
One analyst at Nomura Securities, Harry Curtis, basically said as much. According to Seeking Alpha, he set a $39 price target on Penn National Gaming, using a 9.6 times EBITDAR ratio (earnings before interest, taxes, depreciation, amortization and rent). He believes this is justified given the “growth optionality” from Barstool Sports.
PENN Stock Should Benefit From the Return of Cash Flow
Since my last article, the company announced the opening of 10 of its 41 casinos in Louisiana and Mississippi on May 21. Its casinos are in 19 states, with no more than 15% of its revenues from any one state. Its operations in West Virginia are scheduled to open on June 5.
The company’s biggest states are Ohio (14% of revenue), Louisiana (14%), Missouri (11%), Pennsylvania (10%) and Indiana (7%). The remaining states are between 3% and 6% of revenue.
As for liquidity, Penn National Gaming looks like it had enough. On May 14, it raised $300 million in an equity offering plus $300 million in a convertible note offering. The investment bank had a “greenshoe” option for 45 days to buy more shares. I suspect that probably happened.
The company claimed it has $1.3 billion in liquidity. That likely includes the $600 million it raised on May 14. I pointed out in my last article on PENN stock that the company said its monthly cash burn was $83 million as of April 20. Its operations will have been closed for about three months by mid-June. So it will still have plenty of liquidity left over.
In fact, on May 11, the company reported its first-quarter earnings and cash flow. It showed that Penn National had lost only $75 million in free cash flow, before its payment of $132 million for Barstool Sports. Its cash and securities balance was $730 million in cash as of March 31. But including the $600 million, it had over $1.3 billion.
What’s Next With Penn National Gaming?
Last year, the company generated $88 million in free cash in Q1. For all of 2019, it produced $513 million in FCF. The year before, it made $260 million.
So, let’s assume that on average it can produce $400 million in free cash flow. Given the company’s present market value of $4.4 billion, its normalized FCF yield is just 9%. I would argue that a more normal valuation would be a FCF value of between 5% and 6%.
That implies that the stock should be worth between $6.7 billion and $8 billion ($400 million divided by 5%). That implies a gain of 50% to 80.2% to the stock price. The price target is between $49.23 and $59.14 per share. Let’s call it $54 on average.
Remember, that assumes that the company makes just $400 million in FCF even though in 2019 it generated $513 million. So there is a margin of safety in my estimate.
I suspect it will take at least a year before the stock starts to reach that level, however. This assumes that there will not be a second shutdown from new novel coronavirus restrictions.
Nevertheless, just as before, I believe patient and long-term investors in PENN stock will be rewarded.