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Bear of the Day: Penn National Gaming (PENN)

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In this volatile, range-bound market, you want to at least be sure that your holdings are supported by strong underlying business trends. This should lead us away from many casino stocks right now, including regional operators like Penn National Gaming (PENN - Free Report) ).

Penn National is an operator of casinos and racetracks throughout the United States. It is primarily a regional operator and may be best known as the manager of the Hollywood Casino chain, although it does own and operate the Tropicana in Las Vegas as well. In total, it manages about 40 properties right now.

At first glance, one might like PENN for its unique growth prospects in the casino business. Regional gaming companies should be able to benefit from legalized sports gambling, for instance. Penn National has also proven that it can grow revenue at a rate that might others in the industry jealous. For the current quarter, the company guided for revenue growth in excess of 49%.

But Penn National’s growth plan is fueled by acquisitions. That top-line expansion it is seeing this quarter is likely due to the closing of its deal to buy Pinnacle Entertainment, which added 12 properties to its portfolio.

Growing by acquiring is a legitimate tactic, no doubt. For savvy investors, though, this knowledge means we must look a bit deeper at the underlying business trends.

In the most recent quarter, Penn National missed the Zacks Consensus Estimates for both earnings and revenue. Its results were also below the company’s own guidance. Management also said it expects Q4 earnings to be $0.90 per share, down from previous guidance of $1.75 per share. This type of swing-and-miss quarter is not what we like to see in this market climate.

Much has been said about slowdown in Vegas and Macau this year, but Penn National does not have an Asian presence, and Vegas is not a huge part of its business. Instead, it was “competitive pressures in Illinois and Mississippi,” as management noted in the earnings report, which may have contributed to the soft results.

Penn National’s weak earnings results and poor guidance obviously led to a plethora of negative estimate revisions from analysts. In fact, seven analysts have revised their estimates for 2018 and 2019 earnings to the downside. Our Zacks Consensus for 2018 is now relatively in line with Penn National’s guidance, while the 2019 mark has plummeted 40 cents to just $1.61 per share.

Earnings, earnings estimates, and—more specifically—earnings estimate revisions are the crux of the Zacks Rank. This downtrend explains why PENN is currently sporting a Zacks Rank #5 (Strong Sell). I would also point out that the stock is currently sporting just a “C” in the Value category of our Style Scores system, despite having lost about 30% in the past six months.

This suggest the recent selling has not quite brought shares down to a reasonable valuation. Indeed, PENN is trading at about 25.6x earnings, which is a premium to its industry’s average of 21.8. Moreover, the stock has a PEG ratio of 2.5, while the industry has an average of 1.5. This suggests the EPS growth that’s supposed to come in the next fiscal year is not coming at the best price.

So why cycle money into an overpriced casino stock with an earnings outlook that just fell off a cliff? I don’t think recent market price action is saying now is the time to make such a move. Overall, I’m not sure many casino options look great right now. The industry is in the bottom 19% of the Zacks Industry Rank and has just one #1 (Strong Buy)-ranked stock, racetrack operator Churchill Downs (CHDN - Free Report) .

I do think REIT options could make sense. The healthy dividend payouts likely keep investors around through volatile stretches. One might check out Gaming and Leisure Properties (GLPI - Free Report) , which—funny enough—is actually a spin-off of PENN and owns a lot of the property Penn National manages.

Leases are locked in for companies like GLPI, so brief downtrends in certain states don’t necessarily affect its business. The stock currently has a Zacks Rank #2 (Buy) and pays a dividend yielding over 7.2% annually.

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