On Monday, Penn Entertainment (NASDAQ:PENN) announced $850 million in new expenditures. 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 proving investors have a preference for lower leverage gaming companies. Prior to the Monday announcement, Penn’s leverage was at the higher end of the group.
Prior to today’s announcement, Penn’s leverage was on the higher-end of peers; however, its free cash flow (FCF) profile was strong given few growth CapEx initiatives,” wrote Engel. “While we believe Penn’s $500M annual FCF and ~10% FCF yield had created a valuation floor for the stock, we fear this floor is now at risk as investors cut 2024 FCF forecasts.”
He rates Penn stock “neutral,” with a 12-month price target of $32. That implies upside of 10.3% from current levels.
Penn’s Big Spend
In Illinois, where it’s the dominant casino operator, Penn is spending $360 million to bring its Hollywood riverboat casino in Aurora ashore. Another $185 million is allocated to bring a riverboat gaming vessel ashore in 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 lone venue of note in the Las Vegas Valley. Penn is also directing about $100 million to add a 180-room hotel at the Hollywood Columbus in Ohio.
Gaming and Leisure Properties (NASDAQ:GLPI) — Penn’s primary landlord — is covering $575 million of the aforementioned costs. But that also means Penn’s long-term rent obligations on the four properties are moving higher. Roth’s Engel notes Penn’s announcement signals the operator’s confidence in underlying demand trends, but the spending is less justifiable if a recession arrives.
“While today’s announcement affirms Penn’s confidence in underlying conditions, these projects also put Penn in a less defensible position if gaming demand does weaken materially,” added the analyst.
Penn Needs to Manage Debt
Gaming companies with lower debt burdens are outperforming this year, and some with hefty obligation are moving to reduce those liabilities. Those are signs that the investment community will likely keep a watchful 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 can’t control the broader economy.
“Assuming the economy and gaming demand holds steady, we model ~$500M FCF in 2023. As such, when combining Aurora/GLPI’s $50M/$225M financing, Penn should build enough incremental cash by YE2023 to fund the entire $850M budget, particularly with CapEx not ramping until 2024-2025,” concludes Engel. “However, this also assumes a steady macro environment, where investors are already pricing in a recession by 2H23.”