Recent shifts in the market have me closing my profitable short position in Las Vegas Sands (NYSE:LVS) for now and looking at potentially taking on a short position in Pinnacle Entertainment (NYSE:PNK).
Pinnacle characterizes itself as a mix between an operating company and a development company. In reading through its annual report, it is clear the company prides itself on growth as it builds new casinos and adds to properties it already owns. Management does a good job of preparing investors for the long road ahead, stating that development costs and interest expense will pose a drag on earnings for some time to come as they ratchet up capacity.
Hurricane Katrina hurt many casino operators that had property damaged in New Orleans. While PNK wasn’t immune to this damage [the company is still settling with insurance companies to collect on damages], the company was able to be opportunistic and collect increased revenue at its boomtown property. This property was one of the few left operating, and revenues skyrocketed for a few quarters until competition was able to bring other properties back online.
Pinnacle is expanding overseas and while international markets only make up a small portion of revenues, the segment is growing faster than the company and may contribute materially in the future. Properties in Argentina and the Bahamas make up the majority of international revenue. The property in the Bahamas has only been open just over a year and could see increased growth as the casino operates closer to capacity.
With all this good news, there are several factors that pose concern. The company’s largest revenue producing property [Lauberge Du Lac] actually declined in Q1 when compared to the first quarter last year. The press release stated that this decline was due to a declining win percentage in the gambling area, but it is concerning that this property may have become somewhat stale in its growth.
Companywide, earnings came in at only 5 cents a share for the first quarter. Management stated that this was due to significant pre-opening expenses, but even if you add those expenses back in, the quarter comes in flat compared to Q1 2006. All the while, the stock commands a 50 plus multiple.
My biggest concern with the company revolves around an issue that has become paramount to our current economy. In order to finance the growth, Pinnacle is saddled up with a significant amount of debt. It is not clear from what I have read so far, but it appears the company will have to raise additional capital to continue its aggressive growth plans. This will either have to take the form of equity issuance [unlikely since the company issued stock early this year already] or through the debt markets. Since the financing environment is rapidly deteriorating, and liquidity is becoming more scarce, this may pose a problem for a company which may struggle during a period of declining real estate prices (deterioration of its balance sheet), and interest rate increases.
The company has yet to report Q2 earnings and if I was long the stock, I would not want to be involved for that earnings announcement as it could have a quick and negative effect on the stock. Furthermore, I may consider beginning a conservative short position ahead of the announcement, and then possibly adding to it on any hint that the company is having trouble finding financing or increasing customer traffic to its resorts. A leveraged company like this in a sector that is experiencing deterioration is a dangerous proposition for an investor.
PNK 1-year chart
Full Disclosure: Author does not have a position in PNK.