Published on: October 11, 2022, 02:30 a.m.
Last update on: October 11, 2022, 02:30 a.m.
On Monday, Penn Entertainment (NASDAQ:PENN) announced $850 million in new spending, but at least one analyst says the spending creates risks and could be poorly timed.
In a note to clients, Roth Capital analyst Edward Engel said the current market environment is showing that investors have a preference for lower-leverage gaming companies. Before Monday’s announcement, Penn’s leverage was at the top end of the pack.
Prior to today’s announcement, Penn’s leverage was at the higher end of its peers; however, his free cash flow (FCF) profile was strong given few CapEx growth initiatives,” Engel wrote. “While we believe Penn’s $500m annual FCF and ~10% FCF yield had created a valuation floor for stocks, we fear this floor is now at risk as investors cut FCF forecasts by 2024”.
He rates Penn shares “neutral” with a 12-month price target of $32. That implies a rise of 10.3% from current levels.
Penn’s Big Expense
In Illinois, where it is the dominant casino operator, Penn is spending $360 million to bring its Hollywood floating casino to land in Aurora. Another $185 million is allocated to bring a river game boat ashore at Joliet.
The operator also told investors it will spend $206 million to double the size of the M Resort in Henderson, Nevada. Following the recently completed sale of the Tropicana on the Strip, the M is Penn’s only landmark in the Las Vegas Valley. Penn is also directing about $100 million to add a 180-room hotel to the Hollywood Columbus in Ohio.
Gaming and Leisure Properties (NASDAQ: GLPI), Penn’s primary owner, is covering $575 million of the aforementioned costs, but that also means Penn’s long-term rental obligations on all four properties are increasing. Roth’s Engel notes that Penn’s announcement indicates the carrier’s confidence in underlying demand trends, but the spending is less justifiable if a recession hits.
“While today’s announcement affirms Penn’s confidence in underlying conditions, these projects also put Penn in a less defensible position if gaming demand weakens substantially,” the analyst added.
Penn needs to manage debt
Gaming companies with lower debt loads are doing better this year and some with heavy liabilities are moving to reduce those liabilities. Those are signs that the investment community will likely be keeping an eye on Penn’s leverage as it moves forward with the aforementioned projects.
For its part, Penn, the largest regional casino operator, can control its FCF-generating efforts, but it cannot control the economy as a whole.
“Assuming the economy and gaming demand remain stable, we model ~$500M FCF in 2023. As such, by combining the $50M/$225M funding from Aurora/GLPI, Penn should generate enough incremental cash for YE2023 to fund the entire budget of $850M, particularly with CapEx that will not increase until 2024-2025”, concludes Engel. “However, this also assumes a stable macroeconomic environment, with investors already pricing in a recession in the second half of 2023.”