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Riding the Rollercoaster

It’s been a wild couple of months for gaming stocks. Don’t expect it to end anytime soon

Riding the Rollercoaster

This year will go down in history as the Year of the Pandemic.

For the stock market, 2020 might be remembered as the Year of the Roller Coaster—from the great March collapse, when much of America was shut down, to manic-depressive April and May when stocks swooned and soared each day on the latest Covid-19 news, to the raging bull of June, which is stampeding upwards as these words are being typed.

The numbers are stunning.

Penn National is a prime example. PENN is trading at $37 at this moment—that’s up from a March 18 low of $3.75, which had collapsed from $39.18 just one month earlier. Put another way, an investor who bought PENN stock in mid-February lost more than 90 percent of her money in a month. An investor who bought PENN stock in mid-March earned a return of 1,000 percent by early June.

When has that ever happened before?

PENN is an extreme example, but it’s not atypical. A similar ride has been taken by the stocks of all the brick-and-mortar casino operators and the slot and gaming technology companies that supply them.

The questions are why this is happening and what it says about the future.

As always, there are divergent views, from the V-shaped recovery seen by bulls, to those who fear that stocks have bounced back too far and too fast without the underlying economic strength to sustain their heady valuations.

Plausible cases can be made for both arguments, and all those in-between, as is almost always true.

The V case says, in fact, that the underlying economy is strong. The record-setting economy of early 2020 was artificially halted by a government shutdown intended to meet an exogenous event—a health crisis.

In response, policymakers acted fast. The Fed flooded the economy with liquidity, assuring that financial markets would function and banks would lend to companies, giving them lifelines. The president and Congress rushed money to consumers and small businesses to hold them over. Companies, whether voluntarily or pressured by governments, aided their clients, ranging from rent holidays to waiving debt covenants.

And now, the bulls say, companies are ready to pick up where they left off. We had a time-out, not a recession.

But there’s also reason for caution, to think stocks might have gotten ahead of themselves and will sink to levels commensurate with the underlying economy, which might not be as strong as the bulls believe, perhaps blithely.

Superficially and anecdotally, the bull argument has been bolstered by the enthusiasm of casino customers reentering newly opened properties.

And yet, half-full casinos are not the platform on which prosperity is built, or so it would seem.

Interestingly, Deutsche Bank chief gaming analyst Carlo Santarelli has published a research note in which he suggests Covid-19 will bring a transformational reduction in the expense base of the casino industry.

Investors are forecasting financial performance of casino operators on an outdated understanding, and are thus underestimating the potential growth in margins, Santarelli said.

Santarelli examined the history of previous downturns compared to his current analysis as he looked at the future of Eldorado Resorts, now acquiring Caesars Entertainment.

Using his new assumptions, Santarelli sees the base EBITDA margin of 28 percent growing to 40 percent on a 30 percent revenue decline.

Eldorado stocks will be extremely sensitive to EBITDAR changes, with every 10 percent change in 2022 adjusted EBITDAR worth $16 a share and every turn of enterprise value-to-EBITDAR worth $20.

And, one should think, what’s true for Eldorado is generally true for other regional casino operators.

Of course, even if there’s a new expense paradigm, casinos will need true economic revival to sustain growth. The recent bounce-backs in employment and reports that next year’s convention bookings in Las Vegas are ahead of 2019 are encouraging.

One place to look for investment opportunities is in the permanent changes that come out of a crisis. In the case of Covid-19, remote gambling has been a winner with the accompanying expectation that many American states will legalize sports betting and online gaming.

That should be good news for companies ranging from Flutter to DraftKings, from Penn National to Eldorado, and the technology providers such as GAN and others, many listed in the U.K. and Sweden.

Products to help avoid infectious disease may comprise another area of permanent change. “Contactless” may become more than a buzzword. That could benefit companies with contactless products, ranging from Everi and Scientific Games on the casino floors to hotel software providers.

Of course, there are risks. Will there be a second wave of Covid-19, and will it be worse than the first? Will all the money pumped into the economy echo back in the form of inflation and its nearly forgotten costs of erosion of household wealth, then to recession in efforts to wring it out of the economic system?

There’s an old expression that stocks climb a wall of worry. Perhaps that’s where we are today.

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