Gene Marcial's Stock Picks August 16, 2009, 8:15PM EST

Marcial: Penn National's Winning Hand

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BW's Gene Marcial

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Penn is one of the leading U.S. regional gaming operators and owns and operates 19 facilities in 15 jurisdictions, including horse racing tracks in Charles Town in West Virginia, which also features slot machines; casinos in Mississippi; and riverboat gaming in Louisiana. Penn also owns racetracks and off-track wagering facilities in Pennsylvania, and manages a gaming facility in Ontario, Canada. Other states in which Penn also operates include Colorado, Illinois, Indiana, Iowa, Maine, Missouri, New Jersey, New Mexico, and Ohio.

expansion strategy?

Despite the collapse in 2008 of the proposed Penn buyout, the company "has never been better-positioned to grow in its history," argues analyst Joel Simkins of Macquarie Capital (USA), who also pegs the stock a buy, with a price target of 40 a share. With an underleveraged balance sheet and with roughly $1 billion in cash, "we believe Penn will continue to pursue a strategy of [same-store] expansion and competitor consolidation," says Simkins. Penn didn't come out empty-handed from the collapse of the buyout deal. The company received $1.47 billion in settlement and breakup fees.

"Penn's capital position and cash flow generation are compelling," says analyst David Katz of Oppenheimer (OPY), who is another bull on Penn, rating it outperform. Penn should generate approximately $385 million in free cash in both 2009 and 2010, even if volume trends remain uneven, figures Katz.

Penn's second-quarter sales and earnings results, which it reported on July 29, reflected soft trends in several of its markets, says Katz, but they were "consistent with our expectation that results will be choppy through the rest of 2009." He recommends that investors buy the stock on weakness.

Analyst Justin T. Sebastiano of investment outfit Morgan Joseph (it has done banking for Penn) upgraded Penn to a buy after its stock declined following the release of the second-quarter results. The relatively feeble numbers, he says, were a function of "property-specific variances," or weakness in some of its facilities, rather than an overall company problem.

strong competitive position

He recommends buying Penn shares based on what he expects will be better results in some of its other markets. In sum, Sebastiano forecasts earnings of $1.33 a share in 2009, on revenues of $2.46 billion, and $1.60 a share in 2010, on $2.60 billion. Last year, Penn earned $1.34 a share on sales of $2.43 billion.

Another believer in Penn is analyst Joseph Greff of JPMorgan Chase (JPM), who lauds its strong competitive position in certain relatively healthy regional markets. Greff, who rates Penn's stock overweight, sees the company generating free cash flow of $2.85 a share in 2010 and $3.06 in 2011.

What distinguishes Penn from most of the Las Vegas gaming companies, he notes, is that it continues to perform well in a difficult environment. One reason: Apart from its strong balance sheet and ample cash, Penn has a "history of responsible capital allocation," says Greff.

Fortified by a solid balance sheet, efficiently managed operations, plus growth opportunities in markets it has yet to conquer, including Las Vegas, Penn is a standout in the beleaguered gaming industry. Imagine the upside potential for tightly run Penn when the economic recovery kicks in and casino fans return to their favorite games.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.