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Penn, Pinnacle, and Boyd – One Winner, Two Losers

TAGs: Boyd Gaming, Editorial, penn national gaming, Pinnacle Entertainment, Rafi Farber

Penn, Pinnacle, and Boyd – One Winner, Two LosersLast week I went into the Big Three Las Vegas casinos in light of the latest monetary developments and expected changes in the credit markets regarding interest rates. This week I’ll do the same thing with three other regional gaming companies in the US: Penn, Pinnacle, and Boyd.

The picture with these three is more obvious than the more balanced strengths and weaknesses of Wynn or Las Vegas Sands, where a case can be made on the bullish or bearish side. With these three, only one is worth holding, as only one seems to be preparing for what’s ahead in the credit markets. The other two will be blindsided. We’ll go into which in a minute. First, a quick review of what’s happening on a macro scale.

Monetary Review

Money supply growth has somewhat stabilized over the past month, but it is still much slower than it was 3 months ago. Compare April 17th‘s H.6 report with the previous going back three months and you’ll see the pattern. All investing, all markets, whether it is in the gambling market or any other, ultimately depends on the money supply. If that stops, goes, turns on a dime, then so will the capital markets. Ideally money supply should stay stable so we can make decisions based on company fundamentals rather than the whims of central bankers, but what can one do when the dollar market is a total monopoly?

In short, money supply is growing, but much slower than before. Therefore, stocks still have a ways down to go before they reach an intermediate bottom. Meaning, now is not a time to buy, but rather a good time to research picks for when money supply growth reverses and goes back up.

We’ll start with Pinnacle.

Pinnacle Entertainment

The decision makers at Pinnacle seem to me to be a bit reckless. They’re looking for growth, but at such enormous costs and at precisely the wrong time that I wonder what these people are thinking. While revenue is up 50% since 2012 on the Ameristar acquisition, that’s about the only good thing that came out of that move. Administrative expenses are up 67%, and interest expense has really skyrocketed 81% to $170M. That is more than its operating income.

With Ameristar came an additional $3B in debt that Pinnacle decided to saddle itself with at the exact wrong time. This has piled its debt to equity ratio to over 300% at a time when interest rates have nowhere to go but up, and even now it can’t handle interest payments without incurring losses. There is no dividend to protect from capital loss, and Pinnacle freely admits that it has no protection whatsoever against rising rates:

“While we may enter into interest rate hedges in the future, we currently have no such interest rate hedges. If interest rates increase, our debt service obligations on the variable-rate indebtedness could increase significantly even though the amount borrowed would remain the same.” (10-K, page 13)

Pinnacle lost some money on previous interest rate hedges it bought in 2011 and has apparently decided that buying them again would be a waste of money. This will probably turn out to be a bad decision. Pinnacle basically has its head in the crocodile’s mouth while any drop of sweat could trigger a big chomp. To top it all off, PNK is nearing 6-year highs despite all this. Stay away or short if you think you can time it well.

The only good development recently is that Orange Capital, which bought a 4.5% stake in the company, is urging it to spin off its real estate, which would be a good and necessary move. It’s surprising that someone had to publicly urge this. It should have been done long ago.

Penn National Gaming

Penn is not the healthiest of casinos, but unlike Pinnacle we can say it is at least trying hard to secure itself and behaving responsibly. The smartest thing it did in November of last year was to spin off its real estate holdings into a separate REIT. This enabled Penn to dump over 60% of its debt load overnight, which is now down to 100% of market cap. Still much higher than either Wynn or LVS, but at least Penn is headed in the right direction here.

The spinning off of its real estate was doubly smart because so much of the quantitative easings since 2008 have gone directly into the real estate market which will, once again, fall badly when the support is finally taken away and mortgage rates rise along with general interest rates. When will support be taken away? Impossible to know for certain, but it will probably come when inflation becomes obvious. The MIT billion prices index has pinned it to a 4.2% annual rate right now. (Multiply the monthly rate shown by 12.)

Penn will hurt together with other casinos when this happens, but not as badly as companies like Pinnacle, who seem to have no clue. Watching what Penn does with the rest of its debt will be the key here. They have had interest rate swaps in the past which expired in 2011. If they buy them again to protect the rest of their debt, Penn will be in a relatively strong position as compared with its other regional competitors.

Boyd Gaming

Back in its heyday in 2005, Boyd had net revenues of $2.2B. BYD was trading between $40 and $56 that year. Today it has annual revenues of $2.9B trading at $12. Back in 2005 it had retained earnings of $474M. Today that’s all gone, now a cumulative loss of $432M. An impairment of over $1B in 2012 is mostly responsible for that. While that is thankfully behind it, Boyd is still suffering from runaway debt.

It is on a debt treadmill and it can’t run fast enough to keep apace. Debt to Equity is 330%, and interest rate swaps expired on June 30, 2011, Boyd has not acquired any new debt protections, and despite interest rates remaining low for now, interest expense is now up to $344M. That number won’t go down without some serious restructuring which will have to be done. You don’t want to be in the way when that inevitably happens.

It is unlikely Boyd will be able to grow its way out of this mess without some fundamental changes to its capital structure, considering the monetary environment we are now in.

Conclusion

The healthiest of the three big regional gaming companies is easily Penn. Wait for money growth to reverse itself and go higher, and they are the best pick at that point. When other casinos fall prey to rising rates, Penn could be in a position to capitalize.

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