2023-11-13 09:00:32 ET
Summary
- We concur with the PENN management, in that its stock is currently undervalued compared to historical means, offering interested investors with the opportunistic chance to dollar cost average.
- On the one hand, the company faces declining profit margins as costs expand and its top-line moderates from the uncertain macroeconomic outlook.
- On the other hand, it is apparent that Mr. Market has discounted the prospects of ESPN Bet, despite the massive potential of new adoption and cross-selling across existing iCasino offerings.
- Based on the obvious moderation in the PENN stock's exponential regression curve, we believe that the sell-off may be over soon, as observed in the recent bounce from the critical support level of $17s.
- As a result of its potential upward rerating, we are cautiously rating the PENN stock as a Buy for investors with higher risk appetite and long-term investing trajectory.
The PENN Investment Thesis Hinges On The ESPN Bet
PENN Entertainment ( PENN ) is a stock that requires minimal introductions to readers, whom have tried gaming in either physical casinos or online platforms.
Particularly, the company operates multiple mixed-use properties across twenty states and sports betting in seventeen states, with its regional/ localized approach being a key differentiator to other gaming companies.
PENN Valuations
For now, the PENN management has highlighted the stock's apparent undervaluation in the recent earnings call, "well below historical trading multiples ."
The same has been observed in the Seeking Alpha's charts, with the stock trading at a TTM P/E valuations of 10.60x, compared to its 1Y mean of 15.63x and 3Y pre-pandemic mean of 18.75x.
While FQ3'23 may be an anomaly in its EPS profitability, attributed to the one-time loss on disposal of Barstool, it is apparent that the company's bottom line has been impacted compared to its pre-pandemic levels.
We believe that the PENN stock may be undervalued for a few reasons. With the elevated interest rate environment, it is unsurprising that discretionary spending for leisure activities such as gaming has been tightened. This is further worsened by the restart of the US federal student loans from October 2023 onwards.
While the US labor remains somewhat robust, there has been a notable QOQ pullback on its Gaming Revenues of $1.25B (-3.1% QoQ/ -4.5% YoY) and the Food, Beverage, Hotel, and other Revenues of $367.3M (-3.84% QoQ/ +19.4% YoY) in the latest quarter.
PENN's bottom-line headwinds have also been worsened by the rising COGS attributed to the rising inflationary pressures, naturally impacting its gross margins to 40.1% (-1.5 points QoQ/ -1 YoY/ -4.2 points from FY2019 levels of 44.3%).
The same has also been observed in its growing annualized operating expenses of $2.04B (+3.8% QoQ/ +29.5% YoY), compared to FY2019 levels of $1.59B.
The only silver lining to these issues is that the PENN management has been prudently reducing its exposure to the elevated interest rate environment through the much needed lease classifications. The latter has directly contributed to the decrease in its annualized net interest expenses of $470M (+1.6% QoQ/ -40.8% YoY) in the latest quarter.
This is further aided by the management's strategic use of balance sheet to temporarily invest in money market funds, yielding $40.8M in annualized interest income (+3% QoQ/ +96.1% YoY).
These efforts have allowed PENN to report a sustainable annualized Free Cash Flow generation of $568M (+33.4% QoQ/ -45.3% YoY), with the management unlikely to add on to its existing debts of $2.71B (inline QoQ/ YoY).
Investors may also be encouraged by the fact that there is minimal debt maturities over the next two years, with only $330M maturing in 2026 and $923M in 2027.
Since it does not pay a dividend, we believe that PENN may have more than sufficient liquidity to pay for the $1.5B ESPN obligation over the next ten years.
The Consensus Forward Estimates
For now, it appears that the consensus is more pessimistic than expected, with PENN expected to report an underwhelming top-line expansion at a CAGR of +3.4%, though with drastically impacted EPS profitability CAGR of -16.2% through FY2025.
This is compared to its historical CAGR of +13.2% and +11.4% between FY2016 and FY2022, respectively.
PENN's ESPN Bet Ambitions
However, we believe that Mr. Market has discounted PENN's partnership with Disney ( DIS ) on the ESPN sports betting, which is expected to go live by November 14, 2023.
While it remains to be seen how the segment may contribute to the latter's top and bottom line performance, we believe the management's original projections have been relatively promising, with a 2027 adj EBITDA generation of $1B and up to 20% share in the Online Sports Betting market.
For reference, one of the US most popular online sports betting apps, DraftKings ( DKNG ), reports FQ3'23 annualized revenues of $3.15B (-9.7% QoQ/ +57.3% YoY) and negative adj EBITDA of $942.64M (+1057.4% QoQ/ -39.8% YoY).
However, we believe that PENN's ESPN Bet may be able to generate an improved top and bottom line result compared to DKNG, attributed to the robust demand for the ESPN Streaming, with DIS' paid subscriber base still expanding to 26M (+3.1% QoQ/ +6.9% YoY ) by the latest quarter.
This is an impressive feat indeed, given the recent hike in subscription fees, implying its highly sticky offerings and the consumers' willingness to spend.
PENN's Successful Case Study In Ontario
Many of these ESPN subscribers are likely to be a gamer as well, with PENN to benefit from the potential cross-selling to its other offerings, once consumers are embedded in its gaming ecosystem, similar to its previous performance in Ontario.
Its bottom line may also benefit from the obvious synergies to its existing gaming offerings, once the integration work is completed and cost optimizations are implemented.
As a result, based on its successful case study in Ontario, we believe that Mr. Market may potentially raise PENN's forward estimates, assuming that FQ4'23 brings forth excellent results with promising forward commentary for the ESPN Bet segment.
Only time may tell.
So, Is PENN Stock A Buy , Sell, or Hold?
PENN 6Y Stock Price
For now, PENN has already returned most of its hyper-pandemic and pre-pandemic gains, reversing much of the optimism observed in its stock prices.
However, based on the obvious moderation in the stock's exponential regression curve, we believe that the sell-off may be over soon, especially aided by the recent stock bounce from the critical support level of $17s, thanks to the bottom line beat in FQ3'23.
As a result of the potential reversal in its prospects, we are cautiously rating the PENN stock as a Buy. However, this Buy rating does not come with a specific entry point, since it depends on individual investors' dollar cost averages and risk appetite.
With the Fed expecting a normalized economy only by 2026, we believe that there may be more pain ahead if the ESPN bet does not turn out as expected. As a result, the stock is only suitable for investors with higher risk tolerance and long-term investing trajectory, since its eventual reversal may be prolonged.
For further details see:
PENN Entertainment: The Correction Is Almost Complete - Buy The ESPN Bet