2023-10-27 06:00:00 ET
Summary
- Accel Entertainment, Inc. is a gaming distributor with potential short-term value due to compressed multiples trading at a discount.
- The market may not have fully captured ACEL's earnings power and asset factors, marking potential value for short-term and long-term investors.
- Over the mid term (1-3 years), capital appreciation may be lumpy, as projected sales + earnings growth could be capped.
Investment brief
The gaming and entertainment business has languished with respect to investment returns over the last decade. The 'pandemic era' saw a revival in the space, especially for on-line operators, gaming distributors and industry suppliers.
Accel Entertainment, Inc. (ACEL) came into the light after topping in August and now presents with more asymmetrical risk-reward asymmetry with starting multiples of 12x forward earnings and 10.8x forward EBIT at the time of publication.
ACEL is a gaming distributor that installs and operates gaming terminals in non-casino venues (like bars, taverns and so forth), and runs a number of ATM's in licensed gaming venues. Its statewide exposure is seen in Figure 1a. The company put up $556.9mm in net gaming revenues in H1 '23 , clipping $585mm in total sales including all other segments. It pulled this to operating income of $56mm and earnings of $19.1mm, down from $38mm in H1 last year.
Examination of the investment facts pattern produces the following recommendations across each horizon:
Economic/Fundamental bias:
(i). Short-term (next 12 months)- potential value due to compressed multiples trading at a discount,
(ii). Mid-term (1-3 years)- value potentially capped due to slow rate of sales and earnings growth, could be balanced by business economics,
(iii). Long-term (3 years+)- potential value given growing FCF/share, expanding returns on capital deployed into business + allocation of growth capital.
Technical bias:
- Neutral across all time horizons (short to long-term).
Net-net, I rate ACEL a buy for investors considering a short and/or long-term horizon. For those looking across the next 1-3 years as a holding period, it may be best to wait on the sidelines for now. Rate buy at $19/share.
Figure 1.
Critical facts pattern that support buy thesis at different holding periods
1. Price-implied expectations
The market has fairly pessimistic expectations embedded into ACEL's market values, which we can ascertain through backward induction.
At $9.90/share and trading at 12.1x forward earnings , the market expects $0.83/share in forward earnings, ~6% YoY decline. It also projects 8-9% pre-tax growth to $105.5mm at 10.8x forward EBIT and sales of $1.15Bn.
The company's value of 1.53x EV/invested capital and trailing rate on capital of 12.2% (discussed later) indicates 3 things:
(1). The market return on its investments is valued lowly, a 0.53x premium,
(2). That the market expects a forward ROIC of 8% (1/(1.53x12.2%) = 8%),
(3). It expects ACEL to reinvest 100% of pre-tax earnings, or $105mm,
(4). That it may compound its intrinsic value by 8%.
This is marginally ahead of avg. consensus earnings growth estimates from FY'23-'25. Intriguingly, the perceived risk in the stock is relatively low, with investors commanding just 5.7% rate of return under these assumptions, ranging from 4.6-15% based on various stipulations.
2. Propensity to outpace market expectations and trade higher
Multiple inflection points within ACEL's economics and cash flow durability suggest its market value may be dislocated from its economic value. In saying that, there are balancing factors to this debate.
Starting with the positives-
- This is an asset-light business model that produces exceptional productivity on assets employed on the balance sheet . It rotated ~$0.4 in gross per $1 of gross assets employed in the TTM, up from $0.32 on the dollar in Q2 FY'22. As a reminder, anything above $0.3 is considered high.
- The pace of cash recycling from NWC investment is also exceptionally fast. Stripping cash out from NWC, it enjoys negative NWC, squaring off with the economics of the business-it receives cash before paying suppliers, as is the nature in the gaming business.
- Side note: I am a little dubious on this as, whilst it is deploying plenty of growth capital (see below), ACEL is also hoarding cash on each passing quarter. So it arguably should be 'penalized' for this, and include cash into NWC calculations.
- The firm is deploying a chunk of its surplus cash into growth initiatives whilst growing cash on hand at the same time. Each new $1 in sales growth saw $0.34 of investment in the last 3 years, mostly to fixed capital and NWC. This is 2.5x the compounding sales growth in this period. You can see the pace of growth investment (all capital above the maintenance investment, which is approximated at the rolling depreciation + amortization charge) across '22-'23 below. This is critical to maintain the pace of sales growth going forward.
- Most critically, the company's economic returns stack up to the rate of its investments. The earnings rate on existing capital has been increasing since 2021 from 10% to 12.2% in the TTM, ahead of the market's expectations. New capital commitments have been high, and the market is pricing $105mm for FY'23, as mentioned. More critically, returns on incremental capital suggest new commitments have been pulling their economic weight. FCF/share has therefore increased from $0.61/share to $1.21/share in the TTM.
- The returns are driven by turnover of unit capital, which squares of with the firm's economics. It places gaming 'units' in the field, which then produce revenues. The margins on these placements are thin, >10% on aggregate. The more units it gets to work, the more it can produce sales/revenues on each one, ultimately driving economic value.
Balancing factors-
- Despite the impressive growth, only ~12% of revenues are booked as cash receipts (OCF) each rolling TTM period. This is suspiciously low. The question is why. For one, the pace of cash flow conversion from NWC and its negative capital could mean it books revenues forward with confidence.
- Revenue recognition is important here, especially on gaming terminals, of which it has $328mm of asset value booked in Q2, made up of 23,759 gaming terminals. Per the company, " [w]hen gaming operations commence, payments are due monthly or quarterly" . So, it is logical to assume these contracts have been projected forward and revenues assumed on this basis. I'd be watching the cash flow margin closely ahead nonetheless.
In summary, the following comparisons vs. market expectations are relevant:
- ACEL's growth could outpace the market's view thanks to strong business returns, high amounts of reinvestment at positive rates of return, and ongoing FCF production.
- Based on this, the market might not have captured the full extent of ACEL's earnings power and asset factors using its discounting mechanism.
This is a bullish factor in the investment debate for a holding period over a long-term horizon.
3. Technicals at odds with short-term prospects
Time and volume at price from Q1-Q3 this year has largely filled the $11-$12 region. The recent selloff has demonstrated two key facts:
(1). A new pattern of price distribution in the $9-$10 range,
(2). A pocket of low usage which in my view will likely be filled.
Market's tend to move from areas of high to low usage, meaning the pocket carved out with this latest price action could see the low usage area being filled, corroborating a neutral view.
Figure 8.
The positive skew of this distribution supports this notion too. It calls for cumulative small losses with the potential for a large spike with the right catalyst (think Q3 earnings). You can see the new range filling the low usage area as well.
Figure 8.
The down thrust off the prior high has sent off 2 downside targets on the point and figure studies, to $8.45 and $7.80. Should it break the lower resistance line shown, I would be looking to these levels with a close eye. ACEL has traded this range before, so it's not unreasonable to see a reversion to this mark.
Figure 9.
Daily cloud chart, looking to the coming weeks-
- Point A was a key downside reversal as it 1) took out the marabuzo line of the bullish top in August, and 2) was clear indication the August rally had exhausted. You can see the enormous buying volume with the doji cndle just 4 days before the top at A, showing this.
- At B we gapped lower and this level was retaken around 1 week later as ACEL tested the cloud top once more but failed at C. We then broke cloud support and this sparked a sharp selloff.
- It has now completed a 3 wave down, with an evening star formation this week at D, in continuation of the longer-term downtrend.
Figure 10.
Weekly cloud chart, looking to the coming months-
- Bulls ignited a rally in June at 1) after a bullish hammer candle confirmed by a subsequent green candle which sparked a run from $9 to the climax top at $12.
- Crossed the cloud at 2) and overtook the marabuzo line of a large red candle way back in '22, a key long-term level.
- Climax top at 3) after (i) it closed above the upper trend line and (ii) couldn't break the previous high from '22. Dark cloud formation after the climax top signalled the reversal.
- Broke through key level once more at 4), couldn't reclaim the previous marabuzo line from '22 and now we are currently testing the cloud top. Next level is the marabuzo line from November '22 at $9.28, below this would see it cross the cloud.
Figure 11.
Valuation and conclusion
The compressed multiples at which ACEL currently sells support the prospect of short-term capital gains (over the next 12 months). It is priced at 12-13% discount to the sector at 12x earnings and 10.8x forward EBIT, respectively.
Medium-term gains (1-3 years) are potentially hindered by forecasted sales + earnings growth, which needs to surprise to the upside in order to change the technical picture from above as well.
Meanwhile, longer-term capital appreciation is supported by the company's economic characteristics, in business returns on capital and FCF/share growth.
Collectively, we have a situation where one can buy ACEL today at a modest price and capture quite an attractive competitive position with projected FCF/growth. Projecting the company's cash flows at its steady state of capital allocation and consensus sales growth out to FY'28, then discounting this at our 12% hurdle rate, gets me to an intrinsic value of $19/share, ranging from $14-$23/share based on various inputs.
Therefore, I rate ACEL a buy on a short-term and/or long-term horizon.
To sum up the investment findings, note the following data points-
- Fundamentals/valuation: A buy is supported for investors with either a short or long-term horizon, those looking at 1-3 years might be best served elsewhere,
- Technicals: Not supportive of a buy rating on any horizon.
I am laying weight to the fundamental picture here. ACEL is currently drowning in cash and it has so much opportunity to grow should it continue at its current trajectory. Markets are concerned on more exogenous factors (rates, inflation, etc.), which may explain the pessimism currently priced in. Key risks include:
- Continued selloff in broad equities spilling over into selective names such as ACEL,
- ACEL missing consensus numbers by a wide margin in upcoming earnings,
- Regulatory changes in the U.S. gaming sector.
Investors should realize these risks in full before proceeding further.
For further details see:
Accel Entertainment: Potential Value For Short-Term And Long-Term Holding Periods