Over the last six months, PENN Entertainment’s shares have sunk to $14.63, producing a disappointing 15.9% loss - a stark contrast to the S&P 500’s 13.3% gain. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
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Why Do We Think PENN Entertainment Will Underperform?
Even though the stock has become cheaper, we're cautious about PENN Entertainment. Here are three reasons why PENN doesn't excite us and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
Examining a company’s long-term performance can provide clues about its quality. Any business can have short-term success, but a top-tier one grows for years. Over the last five years, PENN Entertainment grew its sales at a 11.9% annual rate. Although this growth is acceptable on an absolute basis, it fell short of our standards for the consumer discretionary sector, which enjoys a number of secular tailwinds.
2. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, PENN Entertainment’s ROIC has unfortunately decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
PENN Entertainment’s $5.53 billion of debt exceeds the $692.1 million of cash on its balance sheet. Furthermore, its 6× net-debt-to-EBITDA ratio (based on its EBITDA of $769.5 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. PENN Entertainment could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope PENN Entertainment can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We see the value of companies helping consumers, but in the case of PENN Entertainment, we’re out. After the recent drawdown, the stock trades at 14.7× forward P/E (or $14.63 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are better stocks to buy right now. We’d recommend looking at the most entrenched endpoint security platform on the market.
Stocks We Like More Than PENN Entertainment
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