Penn Entertainment: Powerful Omnichannel Position in a Competitive U.S. Gaming Market; Shares Cheap

We have initiated coverage on Penn Entertainment PENN with a $27 fair value estimate (a 10% discount to trading levels) and no-moat rating. In our view, Penn’s attractive omnichannel presence positions it well in the domestic gaming landscape, where we estimate it to have held 11% of the commercial market in 2022. The firm’s portfolio includes over 40 casinos across the U.S., which combined produced healthy EBITDAR margins of 36.7% and represented 90% of total sales in 2022. In turn, we believe these brick-and-mortar locations help Penn receive digital gaming licenses, some of which it awards to third-party partners, driving a growing interactive business. Also, the firm’s acquisitions of Barstool in 2020 and theScore in 2021, along with its Penn Play loyalty membership of 27 million individuals, add demand channels and technology resources, aiding its growing digital business. As a result, we expect Penn’s interactive segment to grow to about 25% of total sales in 2027 from 10% in 2022 and for EBITDAR margins in the division to reach 20% in five years, compared with negative 11% last year.

Despite our sanguine view of the firm’s position in the domestic gaming industry, we don’t think Penn’s business derives a competitive advantage, given low barriers to entry. In fact, the U.S. gaming market is composed of about 1,000 commercial and tribal gaming casinos, representing one casino for every 334,00 people, compared with 2.8 million and 39 million in the Singapore and Macao gaming markets, respectively. We don’t expect this supply dynamic to alleviate for the foreseeable future and continue to expect ongoing competition through new and renovated casinos across the domestic markets versus our expectation for no notable incremental casino additions in Singapore or Macao for the foreseeable future. Thus, we think Penn’s returns on investment capital (including goodwill) will amount to just 3.2% on average over the next five years, well below its 8% cost of capital.