Are Investors Too Optimistic On Penn National Gaming Stock?

After surging by 620% since the lows observed in March, at the current price of around $32 per share we believe Penn National stock (NASDAQ: PENN) has reached its near-term potential. The stock has rallied from $4 to $32 off the recent bottom compared to the S&P 500 which moved 40%. It outperformed broader markets because of the successful public offerings last month which has bolstered its balance sheet with $300 million of additional share capital and $300 million of debt. The stock has fully reached the level it was at before the drop in February due to the coronavirus outbreak becoming a pandemic. This seems to make it fully valued as, in reality, demand and revenues will likely be lower than last year.

The recent rally can also be attributed to the 60% growth seen in Penn’s revenues from 2017 to 2019. While the top-line growth was driven by multiple acquisitions over the past three years, the growing interest expenses and impairments have been a drag on margins. However, the company’s adjusted EBITDAR (Earnings before interest, taxes, depreciation, amortization, and rent expense) has observed an 83% jump since 2017, supported by growing revenues.

Interestingly, the P/S multiple has also observed a continuous upward trend after declining in early 2018 despite the near-term pressure on margins from expanding long-term debt and lease obligations. A key factor behind the trend is the 2-percentage-point improvement in EBITDAR margin. However, we believe the stock is unlikely to see a significant upside after the recent rally as the potential weakness from a recession driven by the Covid-19 outbreak could lead to top-line erosion. Our dashboard What Factors Drove 3.6% Change in Penn National Gaming Stock between 2017 and now? has the underlying numbers. Penn’s P/S multiple changed from 0.9 in 2017 to 0.6 in 2019. While the company’s P/S is now 0.7 there is a downside when the current P/S is compared to levels seen in the past years, 0.6 at the end of 2019 and 0.5 in 2018.

So what’s the likely trigger and timing for a further downside?

As casinos in Las Vegas and other regions re-open with strict social distancing and safety protocols, a resurgence in the coronavirus spread at these popular entertainment destinations could prompt regulators and public health officials to take stringent measures. However, over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus, which helped allay systemic fears, the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations vs historic valuations become important in finding value.

While Penn National stock has a low upside potential, which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.

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