The only thing harder than buying when you’re scared is selling when you’re happy. US regional gaming stocks are at or near all-time highs or at least decade highs, and there is no compelling reason to assume they will keep going higher, future mergers notwithstanding. There has been no compelling fundamental reason why they have skyrocketed so quickly and as high as they have either. I understand 20%, 40%, or even 50% higher in a year or two, but doubling is a bit much. It looks to be a case of trend followers piling on top of trend followers.
Penn National Gaming (PENN), Pinnacle Entertainment (PNK), and Boyd Gaming (BYD) have all skyrocketed over the last 12-18 months. This could theoretically make sense if all three were in store for a decade or more of uninterrupted growth and smooth sailing for the US economy from here, but that’s not going to happen. All three of them have been extremely volatile on the way up, which means they are more likely to be extremely volatile on the way down, and the way down is coming this year it looks like.
Penn in particular has already fallen 25% since topping, and stock market trouble has barely started. Penn’s fall hasn’t been much though compared to the spectacular rise since November 2016 when the stock was trading at around $12. We’re still 130% above those levels, which tells you how crazy these stocks have been.
Taking a look at the three individually, Penn’s EBITDA is down 24% since bottoming in 2016, and with inflation climbing and debt service already eclipsing operating profit, without organic top line growth its bottom line is going to stagnate at best. While Penn’s debt situation has improved since spinning off its real estate, it doesn’t justify a doubling, even with a Pinnacle merger pending.
As for Pinnacle, it has quadrupled since February 2016 and it is unlikely to go substantially higher because the merger price has already been set. It has resisted the fall in the S&P up to now and price is coiling very tightly between $30 and $32 ever since volatility returned to stocks in February. Since a price is already agreed upon between the Pinnacle and Penn, there won’t be much movement here until after the merger is completed.
Fundamentally on its own, if not for the Trump tax cuts, Pinnacle’s bottom line would be about 20% below where it was in 2015. Perhaps Penn is paying too high a price then. While there is growth in Pinnacle, it doesn’t justify a quadrupling in its stock price.
As for Boyd, it is probably the most fundamentally sound of the three. It has decent growth that sort of justifies its 150% climb since February and it is the only one of the three that has yet to break all time highs sent pre-2008. It is also the only one of the three with a dividend. Debt is not a significant problem until 2021 at the earliest, but on the downside it is the most volatile of the three. Especially after the Penn Pinnacle merger, it will be more isolated and possibly even more volatile than before.
Before anyone considers buying any of these sky-high valuations, consider what happened to these stocks in 2008. Penn lost 66% from top to bottom, Pinnacle 80%, and Boyd over 90%. Another downturn in the US and something similar can happen again. We can get a good idea if there is any serious threat of this by tracking the movement in Penn shares when the Penn/Pinnacle merger goes through in the second half of this year. It should go through by then considering that the Illinois Gaming Board just gave the green light for it last week.
A buy-the-rumor sell-the-fact type of situation is quite possible here, where traders line up to sell Penn once the merger with Pinnacle is finalized thinking that there will be many buyers because of the completed merger. The move is expected to benefit both companies by yielding $100M in cost savings within two years. Even though the merger looks like a good idea for all parties, I don’t think it will be enough to propel the combined company to new highs consistently, at least not in the near future.
By the second half of this year, considering tightening monetary conditions, US stocks should be falling across the board and all three regional gaming stocks should be well off their highs along with the S&P 500 and the Dow. Unless the indexes clearly break to new highs really soon, it looks like the top for the year is in.
What the regional gaming stocks will be good for is on the way back up. While not in picture perfect health, they should all survive the next recession, though battered, and then climb back up to around current levels. Assuming they can continue to keep their debts manageable, they should all be good gainers once the worst is over.
