By Howard Jay Klein
Price at writing: $11.70
Note: The House Edge subscribers had a 48-hour advance look at this research.
Last October, we shared with The House Edge subscribers a buy signal on Pinnacle Entertainment (NASDAQ: PNK) then trading in the 30s. Our contention then was that PNK was the pick of the regional gaming litter. While the proposed REIT transaction with Gaming & Leisure Properties (NASDAQ:GLPI) was announced but not yet signed, we believed the intrinsic value of the company, as an operator wouldn't be impaired by the deal. And a dividend flow could make up for any hit the stock could take longer term.
As we've often stated, we've never been great fans of REITs for gaming companies for a number of reasons. Our primary concern is that long term, gaming properties are single use buildings, which in a recession or worse, have significantly reduced values against that which they commanded when the deal was done.
However regardless of that bias, we remained fans of Pinnacle because in our analysis of the management, property quality and locations, and outlook for the US regionals, this company, as an operating entity alone, had the best, most diverse portfolio of all the gaming regionals.
PNK operates 15 casino properties in Colorado, Indiana, Illinois, Louisiana, Mississippi, Missouri, Nevada and Ohio.
Since then there's been nothing but good news about Pinnacle, yet it remains mired in a narrow trading range post-REIT between $9 and $12. Consensus target is $19, a number we believe, short changes the upside for this stock immensely, which is why we see a buy signal on the shares now.
Last October, we cited Pinnacle for our subscribers as the US regional gaming stock that regardless of selling its realty to the Gaming & Leisure Properties REIT, we liked the company's prospects going forward.
At the time of our recommendation, PNK was trading at $36 largely in anticipation of the closing of the REIT deal by Q1 2016. GLPI paid $4.75 billion for the PNK realty.
Shareholders received 0.85 shares of GLPI for each of their PNK shares. This valued all of PNK at $47.50 a share. PNK holders now also own 27% of GLPI currently trading at $34. This adds an implied $17 of value to the $11.70 PNK current price totaling $25.30 a share for PNK holders. Add to this the current dividend of $2.24 a share from the REIT distribution and you have a total of $25.30 if you've neither added to your GLPI nor PNK holdings at the close in Q1.
In addition, those GLPI shares also represent a holding for PNK in the Penn National (NASDAQ:PENN) realty portfolio of regional gaming and racino properties, with GLPI now totaling 35 operating casino/hotels nationally. This past March, GLPI also acquired the Meadows Race Track & Casino (Harness racing) (near (Pittsburgh) for $135 million expanding their reach into that space as well. (PNK has a management contract for the Retama Park racetrack near San Antonio).
Here's what's happened since:
1. The REIT deal has closed; PNK has reported Q1 results:
Analyst EPS estimates: 0.64 per share.
Actual 0.83 per share, a beat of 19c.
Net income actual: $41 million.
Analyst estimates: $577 million
Actual: $580 million
2. GLPI Q1 earned 0.70, a 1c beat over analyst estimates. Assume in theory that PNK shareholders implied value in that earnings number in direct ratio to its equity in the company would add 17c to PNK's earnings totaling $1.00. This is a strong performance for both.
3. Share buyback
On May 27, PNK announced a share repurchase program totaling $50 million as an expression of management's confidence in the strength of its balance sheet, cash flow profile (It generates 0.18 to net sales in cash flow. Since in 2011 PNK's cash flow is up 24.93%).
On this news, the stock was up 4.5%. The buyback is for 4.6 million shares representing 7.6% of the outstanding total.
4. Leverage vs. performance
We're comfortable with PNK's leverage, which indicates a 3.5X ratio for 2016.
2015 total revenues: $2.29 billion.
Long-term debt: $3.615 billion
Cash flow from operations: $91.48 million
P/E: 11.94 - we believe this is cheap given the fact that the stock has been batted down largely by transaction-related movements to a level where we see a rebound coming.
Annual rent obligation under the triple net lease to GLPI:
$377 million per annum places it around 17% of revenues, well within what we believe is a highly manageable ratio going forward against PNK's improving cash flow numbers.
5. Analyst's price target is $19. This is where we part company with the consensus. Our guidance is for $26 closer to the implied value created by the REIT transaction.
Our 360-degree view
As part of our regular private consulting research, we do a monthly call around to colleagues and friends to take the temperature as it were, on the performance of the three major gaming sectors: US regionals, Las Vegas Strip and Macau. These calls include the markets in which PNK operates.
Our sense of the marketplace now:
1. Overall revenue streams are stable with some outperforming others, as is always the case. For example, the explosion of tavern slots in the state of Illinois has impacted properties both in Illinois and Indiana. On the plus side, properties like the PNK flagship L'Auberge in Lake Charles, Louisiana, whose key feeder market is Houston, 2 hours away by car shows strong upside momentum in both gaming and non-gaming revenues.
The 1,000-room 242-acre property is a Vegas scaled operation offering an amenities palette that includes a golf course, 70,000 square feet of casino space, comprising 1,600 slots, 80 table games, a broad package of popular and gourmet priced dining options and according to our sources, a solid reputation for customer service. The property has benefited from the superior performance of the Texas economy over the last three years though, there has been some oil patch bruising that has slowed the pace.
On a market-by-market analysis, our primary inquiries to our network of colleagues was to find out if PNK's properties were a) maintaining a competitive marketing profile. The answer was yes. b) Operating efficiently with improving margins. The answer was generally yes. c) Likely to encounter major headwinds in the overall market. Other than some concern about continuing poaching from Illinois tavern slots the consensus gathered was that PNK was well positioned to sustain its stability against any foreseeable headwinds now gathering in the macro economy.
Nobody claims immunity for the company should we slide into a national recession. In that contingency, all companies in the space will be challenged.
Our take on PNK is that at its current trading range, it looks like a buy to us. (A number of small hedge funds have recently bought the stock on earnings and prospects post-transaction). The generally sound financial decisions made during the transition period buoyed by the recent buyback announcement supports management's belief that its strategy will produce results that make its stock cheap.
Also we believe the coming consolidation of US regional gaming in general auger well for PNK as a company with a strong financial base, to become an acquirer of smaller competitors going forward.
PNK has a good outlook at a cheap price for savvy value investors.
Publisher's note: This article is not presented as standard security analysis, even though we use many of the same metrics applied to that discipline for context only. Our opinion on this stock is based on our view of the company from the perspective of a casino industry veteran and consultant, to provide a 360-degree view of the company and its prospects.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.