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The New Normal

Looking forward means understanding where we’ve been and how we view the future

The New Normal

With a quarter of 2021 experience in hand and first-quarter earnings season about to launch, now is an appropriate time to check in on some interesting trends.

  • Forget about last year and next year. Thanks to Covid-19, and maybe the pressure on analysts to justify high target prices, we aren’t comparing financial results to last year or valuing companies on next year’s forecasts.

Instead, historic comparisons now come against 2019, the last normal year, and valuations are often based on 2023, which some might suspect will be the next fully normal year, though 2022 strikes me as more appropriate.

  • And so far, so good. Gaming revenues from states that have reported March results as of this writing are encouraging that casinos not only are on the rebound, but already are beating 2019, the last year of normal operations before Covid.

Iowa legacy gaming revenues rose 16.8 percent and Ohio 17.2 percent as examples. There also have been down states, such as Illinois at minus 16.3 percent. But it appears regional gaming revenues, at least, are back.

  • As for digital, what the heck? Let’s value companies at 30 times revenues or 60 times EBITDA five years out.

Investors buying stocks like DraftKings at such astronomical valuations will be rewarded long-term by growth. That may prove true. The classic case is Amazon, which was way too expensive for years, and now that it is highly profitable, those prices were very cheap.

But it is a bet. We’ll see how it plays out.

  • There ain’t no such thing as bad news. Profits fall. Guidance is abandoned or lowered. No problem. Stock prices rise as investing in many companies becomes more a leap of faith than a mathematical calculation.

So, the classic question: Are we in the early or middle stages of a great bull market, or are many stock prices seemingly unattached to fundamentals proof that the bear is about to pounce?

  • Margins, margins and more margins. The reason for so many U.S. casino operators to report higher profits on lower revenues is their big-time cost-cutting and the belief they can maintain that cost discipline even when business volumes return to normal.

Perhaps the starkest example of this phenomenon at work was presented by Golden Entertainment, which fell somewhat short of fourth- quarter expectations. CFO Charles Protell gave a simple illustration to investors on the company’s investor call: Retain five percentage points of the margin improvement on $600 million in casino revenue to generate $30 million in free cash flow and, at 28 million shares, that’s better than a dollar a share in free cash flow. The next day, analysts produced big jumps in their target prices and the stock shot up over 15 percent in the next several trading sessions.

  • Market share or profitability. Take your pick. Investors have two nearly opposite choices in the proliferating world of online sports betting and iGaming.

On one side are the big operators grabbing 25, 30, even 40 percent and more market share—FanDuel, DraftKings, BetMGM, Barstool and to a lesser extent so far, William Hill. These operators, or so the theory goes, will be the survivors once the industry matures and consolidates, and then they will make tons of money.

On the other side are the smaller operators who say that, rather than spend wildly to buy market share, they focus on profitability—Rush Street Interactive, Golden Nugget Online, Churchill Downs, Score Media.

We tend to lean toward those that emphasize profitability, though none are profitable yet as even they have to make upfront investments in all of the new markets. We would add Caesars to this list. While a large company about to get larger with the acquisition of William Hill, CEO Tom Reeg is laser-focused on profitability.

  • How REIT they are. Unquestionable winners in brick-and-mortar gaming during Covid have been the three REITs—Gaming and Leisure Properties, VICI Properties and MGM Growth Properties.

Pre-Covid, many REIT investors preferred companies with diverse tenants. But as shopping malls and office buildings got slammed by the pandemic, casinos paid rents steadily and reliably. Now, the gaming REITs have not only proven themselves in a stressful time, they all are positioned to continue growing their portfolios, rents and, importantly to investors, their dividends.

  • We’re all grown up now. The recent addition of Caesars and Penn National to the S&P 500 was a well-earned achievement by two companies of modest beginnings—Caesars from Bill Harrah’s Bingo Hall and Don Carano’s Eldorado casino, both in Reno, and Penn National from a single minor-league racetrack outside of Harrisburg, Pennsylvania.

But it also is a tribute to the growth of the U.S. casino industry. Caesars and PENN join Las Vegas Sands, Wynn Resorts and MGM Resorts in listing among America’s blue chips.

Given the small size of the gaming industry, that’s pretty good representation.

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