2023-04-19 03:58:39 ET
Summary
- Given its cap rate, cost of debt and capital structure, the shares are at about where they should be.
- GLPI is a "spread investor". It creates value by borrowing at lower rate than its cap rate. Assuming a cap rate of 8.03%, investors can expect a 9.45% total return.
- For an investor looking to initiate a position and some margin of safety, a price under $50 would be worth considering.
Introduction
In 2013, Penn National Gaming* (PENN) set in motion a series of internal restructuring transactions and subsequently spun off their real estate assets into the newly formed Gaming and Leisure Properties, Inc. (GLPI). They subsequently entered into a master lease with GLPI for almost all of the previously spun-off assets. The spin-off allowed GLPI to pursue transactions with competitors of PENN that would not have been possible without the spin-off. Furthermore, by electing to be taxed as a REIT, GLPI avoids a layer of corporate taxation, an option not available to PENN. As a REIT, GLPI is able to attract income-oriented investors and can potentially grow its portfolio by diversifying its tenant base into other industries.
Source: Wikipedia , GLPI Prospectus . * In August, 2022 Penn National Gaming changed their name to Penn Entertainment.
GLPI’s business model “consists of acquiring, financing, and owning real estate property to be leased to gaming operators in triple-net lease arrangements. Triple-net leases are leases in which the lessee pays rent to the lessor, as well as all taxes, insurance, utilities and maintenance expenses that arise from the use of the property.”
Source: GLPI 10-K 2022
For its business model to work, GLPI has to access capital at a lower rate than its competitors and the rental income it earns must be more than its cost of the capital. GLPI is a “spread investor”. They obtain capital from creditors and investors and put that capital to use by acquiring real estate assets and leasing them out. The rent they earn pays off their creditors and what is left over is given to equity investors.
In this article, we evaluate the spread that GLPI’s business model is able to generate. We look at the capitalization rate that they can earn and their cost of capital. We decompose the cost of capital by looking at the cost of debt and their capital structure. We infer a reasonable rate of return incorporating the “spread investment” perspective and consider the current stock price in light of this.
Capitalization Rate
Here is a Table from GLPI’s July 2022 investor presentation .
GLPI Corporate Update July 2022
As the reader will note, the Table shows their average cap rate is 8.03%. For them to generate value, the cost of capital must be lower than 8.03%. The lower the cost of capital, the wider the spread, the more profits, ceteris paribus.
Cost of Capital
In estimating the cost of capital, there are four inputs: the cost of debt, the cost of equity and the respective weights of debt and equity in the capital structure. GLPI does not have preferred shares and, by virtue of their REIT status, the tax shield is omitted from the cost of debt calculation. Three of the inputs: the cost of debt, the weight of debt and the weight of equity in the capital structure is straightforward. The cost of equity is something we will infer.
Please take a look at Table 1 which provides the equity market capitalization, and the book value of debt and the corresponding weights.
Table 1: Capital Structure Weights ($ in billions) | ||
$ | Weight | |
Equity Market Capitalization | 13.553 | 68.86% |
Book Value of Debt | 6.125 | 31.14% |
Source: CNBC on 4/17/22, GLPI 10-K 2022
In Table 2, I estimate the cost of debt using the interest expense for 2022 and the average value for long-term debt for 2021 and 2022.
Table 2: Cost of Debt | ||
2021 | 2022 | |
Long Term Debt ($ in millions) | 6552 | 6128 |
Interest Expense ($ in millions) | 309 | |
Cost of Debt | 4.88% |
Source: GLPI 10-K for 2021 and 2022
Using these inputs, I get the result that the cost of equity, from the company’s point of view, should be less than 9.45%. For a step-by-step process, please see Table 3.
Table 3: Inferring the Cost of Equity | |||
Step 1 | Cap Rate | > | WACC |
Step 2 | Cap Rate | > | (Wd)(Cd) + (We)(Ce) |
Step 3 | 0.0803 | > | (.3114)(.0488) + (0.6886)(Ce) |
Step 4 | 0.0803 | > | (.01520) + 0.6886Ce |
Step 5 | 0.0651 | > | 0.6886Ce |
Step 6 | 0.945 | > | Ce |
Legend
WACC = weighted average cost of capital
Wd = weight of long-term debt in the capital structure
We = weight of equity in the capital structure
Cd = cost of debt
Ce = cost of equity
In step 1, we say that the cap rate earned on the rental properties must be more than the weighted average cost of capital to finance those properties in order to create value. In step 2, we decompose the weighted average cost of capital into the weight of debt, cost of debt, weight of equity and cost of equity. In step 3, we plug in the numbers and in steps 4 and 5 we simplify. Finally, in step 6 we get that the cost of equity is less than 9.45%.
From GLPI’s perspective, one interpretation of foregoing is that given the capital structure, the cost of debt specified and the cap rate presented, offering investors less than 9.45% return should be sufficient to attract their capital. Cost of equity is the terminology used from the perspective of the company. From the investor’s perspective, cost of equity is the required rate of return. From an investor’s perspective, given the capital structure, cap rate and cost of debt given, a return of 9.45% is probably the most that can be gotten, in theory.
We arrived at the investor’s rate of return after using inputs from observable data and evaluating the spread. There are other ways to calculate an investor’s rate of return. One of the other methods is to look at the current dividend yield and the dividend growth that can be expected from the investment. The current yield plus the growth rate gives you a reasonable measure of what total return an investor can expect moving forward. This is a different method of calculating an investor’s rate of return and in a perfectly efficient market, we should get an answer of 9.45%.
The dividend yield is straightforward. According to Yahoo! Finance , the forward dividend yield as of April 17th is 5.57%. Please take a look at Table 4 which shows the dividend growth rate of regular dividends for GLPI since 2014.
Table 4: Dividends per share ($) | |
Year | Dividends per Share |
2014 | $ 2.08 |
2015 | $ 2.18 |
2016 | $ 2.32 |
2017 | $ 2.50 |
2018 | $ 2.57 |
2019 | $ 2.74 |
2020 | $ 2.50 |
2021 | $ 2.66 |
2022 | $ 2.80 |
CAGR | 3.79% |
Source: Seeking Alpha , GLPI 10-K for 2022
In Table 5 we combine the dividend growth rate and dividend yield to get the investor’s estimated return using this approach.
Table 5: Total Return Estimate | |
Dividend yield | 5.57% |
Dividend growth rate | 3.79% |
Total return | 9.36% |
So, in decomposing the spread, we said that the cost of equity, which is also the investor’s required rate of return should be at 9.45%. The method of decomposing the spread to arrive at a measure of return is computational, incorporating observable data. An arguably more tangible way for an investor to measure the return would be to combine the dividend yield and the dividend growth rate and come up with what can be expected from the investment. It is more tangible because the dividends are what actually go to the accounts of the investor. Using this method, we arrived at 9.36% which is remarkably close to 9.45%. What does this mean?
My first takeaway is that the shares are close to fairly valued. From my experience, the numbers are usually not this close. We used two different methods of calculating a return and arrived at numbers that are within nine basis points. Perhaps a sign of algorithmic trading?
My second interpretation is that management is getting a slightly better deal vis-à-vis the investor. There is a natural tension between the equity investors wanting more of the profits given to them and management wanting to retain or spend the profits on activities that make it easier for them to do their jobs. Having said that, there is a limit as to how much management can do this given their REIT structure. And quibbling over nine basis points seems persnickety.
For those contemplating initiating a position, at a price of $50, the dividend yield and the dividend growth rate would combine for a total return of 9.45%, the same as what the “spread analysis” showed as the theoretical maximum that investors can ask for given the capital structure and cost of debt of GLPI.
Conclusion
GLPI creates value by earning more in triple-net leases than their cost of capital. The wider the spread, the more value is created. By taking a spread investment perspective, we assess how much of that value created is going to the investor, versus the company and creditors. From this perspective, a total value of a 9.45% return is probably the best that equity investors can hope for in a normal market. Currently, investors are earning about 9.36% which implies that there is 9 basis points left on the table. Should the price drop to $50, investors may want to consider this a prudent entry level.
For further details see:
Gaming and Leisure Properties: Spread Analysis Indicates That It Is Fairly Valued