"The key to investing is not in assessing how much an industry will affect society or how much it will grow, but in determining a company's competitive advantage and, most importantly, the durability of that advantage."
– –Warren Buffett, capital1999
Few business models are more reliable than that of a casino. People love to gamble and because the house has a statistical advantage over its customers in every game, the more people play, the more the casino does. Factor in all of the money people are spending on food and entertainment in those bright, windowless boxes and you will understand why casinos are inherently good business.
So in normal times.
COVID-19 has turned the world upside down, especially for businesses that rely on large crowds: theme parks, cruise ships, concert halls and, of course, casinos. While most of these companies remain deeply depressed, casinos – especially the regional ones where people go gambling from home for an afternoon or evening – are making a remarkable and unexpected comeback. Even so, one casino stock – Gaming and Leisure Properties (ticker: GLPI) – hasn't fully recovered. That makes it a very good bet indeed.
GLP is the founding of entrepreneur Peter Carlino, who took over Penn National, a racecourse near Hershey, Pennsylvania, nearly 50 years ago, making it the largest regional casino company in the country. Carlino's father, who started out modestly as a florist in Philadelphia, was a serial entrepreneur who sent his son to central Pennsylvania to oversee some of the family businesses, including the racetrack. In 1989 the family won the new offftrack betting license in the area and Carlino's father tapped Peter to run it.
With little else to entertain them, the Central Pennsylvanians poured into the Carlinos' OTB salons. It quickly became the best moneymaker in the family and Peter Carlino felt that he had found his calling. “Taking bets on horses at the OTB window is much more profitable than the route itself,” he recalls. "We're up to something."
Carlino took Penn National public in 1994, around the same time that many legislators, eager for more tax revenue, began legalizing casinos. Carlino wanted to join in and started buying them all over the country. In 2000, he bought another racecourse, this one in Charles Town, West Virginia, in the hopes of passing a local referendum to legalize gambling. An earlier move had lost 2-1, but Carlino spent a year in Charles Town and used his considerable charm and energy to reverse the result. In the second vote, the margin was 2 to 1 instead of 2 to 1.
Carlino decorated the new casino with flashing lights and named it Hollywood. The West Virgins were drawn to the sparkle and pizzazz and made Hollywood a huge hit. This raised enough cash to allow Carlino to build or acquire the top St. Louis, Kansas City, Baton Rouge and Columbus casinos, all of which have the same glitz as West Virginia.
Like a quarry or a cable TV company Regional casinos are inherently good business. Local economies can only support a few of them, and states often limit the number of licenses issued, thereby limiting the number of competitors. When combined with Carlino's talent for bringing flair to Central America, Penn National became a hugely successful company. From its IPO through 2013, Penn National posted an annual return of 22.5%, which is three times the average price of the S&P 500 during that period.
A breakup and a surprise
In 2013, Penn National split in two: One company owned the casino licenses and ran the operations, while the other owned the properties and acted as the operator's landlord. The same structure – an “asset light” company and an “asset heavy” company – had worked well in the hotel industry. But it surprised many when Carlino decided to run the landlord – the company that became Gaming and Leisure Properties – instead of the operator. However, a look at the underlying fundamentals explains why.
Unlike in the hotel industry, the casino operator has to pay for all investments, either for maintenance or for extensions. The landlord pays nothing. Better yet, Carlino structured the separation in such a way that the rental costs had to be paid to the landlord before interest was paid to the banks. Indeed, since all you have to do is sit back and collect the rent, renting a portfolio of regional casinos is very good business.
While the company's 46 properties had to close at the start of the pandemic, they have all now reopened, with impressive results: revenues are down 10% year over year, but operating profits are up 20%. How can that be? One of the many unintended consequences of COVID is casino activity that is at high risk for the virus to spread,Table games like blackjack and pokerand all-you-can-eat buffets are also the least profitable but have had to close. Slot machines, on the other hand, can be far apart, require little human interaction and are therefore safe to play. Fortunately for casinos, slots are also one of the games with the highest profit margins.
It came as no surprise when COVID hit the shares of Gaming and Leisure Properties, but given the above, it's strange that the stock has fallen more than 10% since the start of the year. I started buying GLPI for clients in the spring and I think it remains an attractive investment today, both in the long term and in the short term.
The attractive economics of GLP make it a great stopover in the long run, especially for those looking for income. As a real estate investment trust or REIT, the company must distribute most of its profits as dividends. In the short term, there are several smaller clouds that are overshadowing the stock and potentially rising soon, giving investors the potential for a relatively quick uptrend of 30%.
When COVID first struck, GLP cut its dividend by around 15%. it also chose to pay for most of it in stock. This was not because GLP's finances were shaky. In fact, GLP is the most regionally diversified among the three American casino REITs. At the time, it was not clear how GLP's tenants would survive the pandemic, and Carlino wanted to make sure the company could meet its commitments. Nonetheless, the dividend cut scared REIT investors, so that GLP has left its competitors behind since the start of the year.
The other blow to the stock is the risk of what is known as an iGaming, or online casino game. Just as states legalized casinos a generation ago in search of new tax revenue, states are now in the process of legalizing both iGaming and online wagering on sports. Some believe that iGaming could divert customers from brick and mortar casinos, just as e-commerce has slowed down traditional pedestrian traffic in retail. However, both the evidence and common sense suggest otherwise. For example, online gaming has been legal in New Jersey since 2013, but Atlantic City casino revenue has grown in four of the last five years. This is because gambling should not only be bought but also experienced personally. There's a reason Carlino built his company around those blinking lights.
"People are social animals," says Carlino. “Are you going to place a bet on a game on your couch? For sure. But will they keep coming back to the casino? Naturally."
GLP has announced that it will restore its dividend on all cash in early 2021. At the current payout of $ 2.40, GLP is trading at a yield of almost 6.5%. This is a discount to historic 10-year Treasury trading. If the cash dividend resumes, I believe the stock will trade at less than 5% yield, meaning the stock should gain around 30% from its current $ 38 to around $ 50 per share. The company should also hike its dividend next year to create further upside potential.
Meanwhile, Carlino stays in central Pennsylvania and does what he always has: run the business, keep an eye out for new real estate deals, and let the stock price take care of itself. "I check the stock price maybe once a month," he says. “My philosophy has always been to put the numbers up; Investors will find out. "
Adam Seessel is a portfolio manager with Gravity Capital Management LLC, a registered investment advisor. Certain of the securities referred to in this article may currently be held in a portfolio managed by Gravity, have been held or will be held in the future. The article represents the views and beliefs of the author and does not claim to be exhaustive. The information in this article is as of the publication date, and facts and figures contained in the article are subject to change.
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