This Stock is a Buy

Over the past two months, Penn National (NASDAQ:PENN) stock has dropped about 5%. Honestly, I’m not sure why that is. It might be that PENN stock simply needed a breather.

Few stocks in the market had a bigger rally off March lows. During the worst of the March selling driven by the novel coronavirus pandemic, PENN dipped below $4. As I write this, it’s at $64 just eight months later.

It could be so-called “second wave” concerns. Covid-19 cases are increasing.

We may see Penn properties shut down again, or at least face restrictions on customer counts and operating hours.

One of Penn National’s horse racing tracks already closed temporarily this month due to Covid-19 cases among jockeys.

Neither of those explanations is good enough, however. Investors are supposed to be focused on the long term, as I’ve been arguing since PENN still traded below $10. Short-term issues like temporary closures or a need for a stock to “settle down” don’t impact that long-term case.

That long-term case remains hugely attractive. What’s more, it’s become even stronger over the past few weeks.

Yet investors have mostly shrugged, and Penn National stock has lagged the market. That sluggish response — whatever the cause — gives investors a chance to buy the stock before the rally resumes.

Promising Election Results

Before the pandemic, Penn’s acquisition of a stake in Barstool Sports sparked optimism toward the company’s role in U.S. sports betting. That optimism was swamped by the “sell everything” mentality that dominated the market in late February and March, but it’s returned with a vengeance.

The logic is that the pandemic will accelerate legalization of sports betting across the country. State governments are facing a “double whammy” of lower tax revenues and higher spending. Holes need to get filled, and tax revenue from legalized sports betting can go a long way toward improving stretched budgets.

Amid the drama of the U.S. presidential election, some investors might not have noticed that the case for faster, broader legalization took a big step forward this month. Referendums passed in South Dakota, Maryland, and Louisiana to legalize sports gambling, part of a clean sweep for the industry as a whole.

Those three states aren’t necessarily expanding the market by a huge amount. Combined, they have not even 4% of the U.S. population.

But what they show is strong public support for legalized sports betting — and in three states with differing politics. That support gives cover to legislators in other states who haven’t yet enacted such measures.

So does the increasing number of states — more than half — that have either legalized or are planning to legalize sports betting.

Simply put, there’s a snowball effect. Sports betting legalization is moving at a rapid pace, which unquestionably is good news for PENN stock.

Earnings Support the Bull Case

News on the political front supports growing optimism toward Penn’s opportunity in sports betting. Third quarter earnings, released late last month, do the same. But they also highlight the strength in the rest of the business.

Penn’s Barstool Sports betting app appears to be off to an excellent start. According to the Q3 release, the app generated handle (the amount wagered) of $78 million in just the first 30 days. Penn didn’t have to spend much on marketing, either; it simply let Barstool and its personalities push the product. Loyal fans did the rest.

Unsurprisingly, Penn’s total revenue took a hit in the quarter, declining 17% year-over-year. Many properties still have capacity restrictions; some patrons still aren’t ready to come back. Penn also dealt with hurricane activity in the South.

The nature of the casino model usually suggests that declines in revenue lead to massive pressure on profits. This is largely a fixed-cost business, after all. That’s not what happened here.

In fact, Penn’s Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) actually rose 10%.

That performance is truly impressive. And it raises an important question going forward: if this is what Penn’s results look like amid so much external negativity, what happens when normalcy returns?

Yet PENN Stock Stays the Same

The answer would seem to be that profits grow dramatically. Margins may take a hit here or there as Penn and its rivals get back to normal promotional spending. But it may well be that the pandemic has highlighted ways in which Penn National, and its industry, can find more cost savings than previously thought.

All told, this is a business that seems set for exceptional growth. Sports betting hasn’t even really kicked in for Penn. And the performance in Q3 (and Q2) suggests the company should manage through this rough patch just fine, with loads of pent-up demand likely to boost results in 2021 and 2022.

Yet PENN stock hasn’t really budged. Nor is it all that expensive. Relative to net profit, PENN doesn’t look cheap, at about 44x 2021 consensus earnings estimates. But it’s important to remember that for casino stocks, earnings aren’t all that useful. Depreciation and amortization expense (which is deducted from earnings) almost always far outstrips capital expenditures (which are deducted from operating cash flow to define free cash flow).

That’s what EV/EBITDA (enterprise value to EBITDA) is often the preferred metric for valuing casino stocks. On that basis, PENN still sits below 10x.

Simply put, that’s not a multiple that prices in Penn’s growth potential. And I expect investors will figure that out again soon. In the meantime, investors have an opportunity.

— Matt McCall and the InvestorPlace Research Staff

Avoid These Kinds of 5G Stocks Like the Plague [sponsor]
The 5G communication build-out is going to be the biggest, most important, most lucrative new “highway” built in our lifetimes. Yet most people are investing in it the WRONG way. Legendary stock picker Matt McCall reveals details about the best 5G stocks to buy now. Click here to learn more.

Source: Investor Place