After returning more than 30% last year, shares have been stagnant as the market awaits them to close on their latest transactions.
The recent Tropicana acquisition allows them further diversification and is highly accretive to support the dividend increase.
Debt levels are now at management's target levels leaving additional cash flows for more accretive acquisitions and/or dividend increases.
We believe that the shares will rise later this year once the transactions close and they raise the dividend or announce a new acquisition.
Members of our marketplace service Yield Hunting received this report first and with additional commentary and guidance.
We last discussed Gaming and Leisure Properties- (GLPI) back in early January after a run in the shares in 2017. The stock returned nearly 30% for investors and was one of our top three picks. Shares bottomed in mid-February as interest rates spiked causing most real estate investment trusts to sell off. Year-to-date, GLPI is down about 3.3%, slightly less than the Vanguard Real Estate Index ETF (VNQ).
The thesis remains the same, strong and stable growth driven by acquisitions in an industry that remains capital intensive with few large players. Many investors in REITs invest across sub-sectors including office, retail, shopping centers, hotels, industrial, etc. However, most of those are not only correlated (inversely) to rates but also correlated (positively) to the business cycle. Defensive names that tend to perform well during recessions and weaker economic times are few and far between. Gambling, cigarrettes and alcohol remain some of the best areas to combat the business cycle.
In the case of Gaming and Leisure Properties, they are the landlord to casinos which we believe is even better. This creates a VERY stable income stream from long-term leases, collateralized, with strong rent coverage.
GLPI is a REIT formed from having the real estate assets of Penn Gaming spun-off approximately 5 years ago. GLPI owns most of Penn's real estate assets and then leases them back to Penn in a sale-leaseback transaction. These a triple-net master operating leases with a term of 15 years plus another 20-year extension in 5-year increments.
The business model is fairly straightforward. They look for casino operators looking to unlock the capital housed in the physical property of the real estate and initiate a sale-leaseback transaction. These come in the form of a triple-net lease master lease.
The business is still very young but they have acquired 38 properties so far with most being from the original Penn Gaming transaction. Right now, the firm is highly dependent on just two operators, Penn Gaming and Pinnacle Entertainment (NYSE:PNK).
(Source: Investor Presentation)
The reasons why we like this REIT is the defensiveness of the category compared to most other REIT and high yield categories. Our goal is an attempt to build a portfolio that generates a strong current yield without taking undue risks on the economy. Diversifying with some yield-plays that are less correlated to the business cycle can produce better risk-adjusted returns in the portfolio.
Right now, we see the shares as being undervalued with the upside thesis as follows:
- Acquisition pipeline remains strong: GLPI has the potential to merge or partner with current tenants to acquire gaming assets outright. In addition they can expand to additional third-party operators.
- More sale-leaseback transactions: Management slowly continues to add new operators including recent deals with Boyd Gaming (BYD) and Eldorado Resorts (ERI). These are two new industry aggregators (casinos that buy other individual casino operators and roll them up into their model). We expect both of them to move forward unlocking their real estate values through sale-leaseback transactions.
- Potential to expand outside of gaming: They have yet to conduct much of anything outside of the gaming space (the leisure aspect!) but do have the ability to engage in similar sale-leaseback in other markets and industries with similar business models. It would likely still be in the entertainment space and management would want similar stable rental income and be immediately accretive.
Internally, the structure of the master lease agreements lend to organic growth escalators to grow revenue. A component of the contract has a 2% annual rent escalator subject to the minimum rent coverage ratio of 1.8x.
Penn Gaming - Pinnacle Entertainment Consolidation
In December 2017, Penn Gaming announced that it was acquiring Pinnacle Entertainment. We wrote extensively about the transaction in our last write up. From that report, we noted:
On December 18th, the company announced an agreement to acquire a property from Pinnacle Entertainment and another from Penn National Gaming, Inc. (NASDAQ:PENN) The purchases add the real property assets of Plainridge Park Casino in Massachusetts and Belterra Park Gaming and Entertainment in Ohio. The deal terms called for $315.2 million in cash and should close in the back half of next year.
The purchase price was done at a fairly compelling 9.8x multiple on annual rent which totals $32 million. Plainridge is the larger piece of the two properties and the Master Lease with Pinnacle will be amended to include an additional $13.9 million in rent on top of the $32 million. The adjustment is to bring rent to current market conditions. The total $45.9 million in additional incremental rent to GLPI will offset some headwind rental impact likely to occur next year.
If total rent rises by $40 million, baking in a $5.9 million rent adjustment next year, and placing a 13x multiple to that income stream, it will add $520 million in value. If we assume that the deal is financed by $300 million in new debt, then the equity value rises by $220 million or nearly $1 per share. But management noted that the deal would be funded with both debt and equity.
More importantly, the deal helps them diversify from largely a two-tenant business. Previously, the tenant rent diversification (the pie chart below) was essentially split between Penn and Pinnacle. This deal adds a third business to further reduce concentration risk. At approximately $40 million in rental revenue, they would account for over 15% of total rental revenue.
The competition among the largest operators is starting to decline leading to more secure rental coverage for GLPI. For instance, with intense competition from the operators, there can be a race to the bottom in terms of pricing and cost of their product (including gaming, food and entertainment). But with fewer operators (Penn, Caesars Entertainment (CZR), Boyd Gaming (BYD), and El Dorado Resorts (NASDAQ:ERI)) there is stronger pricing power among the remaining with Penn (GLPIs largest tenant) being far and away the largest in the space.
Adding Boyd Gaming to the tenant mix helps to further diversify their exposure with one-ninth of their pro forma rent revenue. The announced deal in December had a concurrent transaction announcement with Boyd to create a new master lease agreement. The new leases is similar to the existing leases but does contain a higher default ratio of rent coverage at 1.4x and no parent guarantee. However, Boyd is a large player in the space with 24 gaming properties and over $2 billion in net annual revenue.
The transaction still has not closed and is expected to do so in the back half of 2018. Management expects that it should add another $0.12 of incremental AFFO per share.
Following the transaction, the geographic diversification of the business will be enhanced.
Tropicana- El Dorado Transaction
On April 16th, El Dorado (ERI) announced that it made two acquisitions. The first is for Tropicana Entertainment for $1.85 billion and the second to engage in a sale-leaseback transaction to GLPI for $1.21 billion for the Tropican Atlantic City, Evansville, Lumiere Place, Laughlin, Greenville, and Belle of Baton Rouge. The initial rent is $110 million per year with rent coverage expected to be not less than 1.85x as defined by the master lease. The term is 15 years with four 5-year renewal periods.
The $110 million income stream with escalation implying an 11x multiple on the real estate income stream or a 9.0x multiple on the $206 million in EBITDA production. The acquisition is calculated to be up to 9% accretive to adjusted funds from operations (AFFO) per share. If we assume a 13.5x multiple to the $206 EBITDA, the incremental share value gain should be just under $2.
From the press release:
The Company expects to fund the transaction with a combination of debt and equity, however, based on market conditions the entire transaction could be funded with debt. Upon completion of this acquisition, along with the previously announced transactions related to the acquisition of Pinnacle Entertainment, by Penn National Gaming, Inc. the Company anticipates its pro forma ratio of Total Debt to Adjusted EBITDA will increase to no more than 5.5 times. In aggregate, the two transactions are expected to result in dividend per share accretion of 8% to 10% on the first quarter annualized dividend of $2.52 per share.
These are the types of transactions that we foresee boosting the share price over the next two years. The pipeline is very robust with plenty of opportunity to engage in multiple transactions over the next two years which we think will finally boost the share price to what we believe is the intrinsic value.
Cash Flow and Balance Sheet Strength
At the end of the first quarter, the company had $45 million of unrestricted cash and $4.4 billion of total debt including $1 billion that has been tapped from their credit facility. The debt is still rated BB+/Ba1, non-investment grade with a credit negative watch stemming from the Penn/Pinnacle acquisition. It remains to be seen if they do get downgraded from the transaction.
One of the other reasons for their negative credit watch was the transaction last year for The Meadows, a racetrack in Washington state. The ability to raise the capital on economic terms was put into question. They also had $735 million of debt due this year that needed to be rolled.
Net debt at the end of the first quarter was 5.0x, down a tick from the fourth quarter. They have plenty of liquidity to perform more deals plus they can issue new equity under their at-the-market offering shelf program. This is where they issue new shares to the market to raise capital. Obviously this is dilutive to existing shareholders but if it can be used for an accretive acquisition, then it may be worth it.
They are now at their long-term target debt multiple of 5x and thus, we think that clears the way for more aggressive acquisitions on the M&A front or further dividend increases. AFFO should be around $3.15 this year so the dividend, recently increased by a penny annual to $2.52, is well covered by 25%.
Once the acquisition closes and they get beyond it, we think there is an opportunity for a credit upgrade which should help them when it comes time to roll debt. The 2020 and 2021 maturities are more than 50% of their outstanding debt. With an upgrade, and all else equal on the rate front, they could save significant sums on interest expenses.
With debt where they want it, they can pre-refund a significant amount of equity for the next acquisition. This is their mechanism for growth. On the call, CFO Clifford was asked about the debt markets and the recent movement of rates in relation to their rolling of their debt.
Obviously the market has ticked up. You got the LIBOR yield curve that's ticked up that we've reflected in our guidance, but we don't see the capital markets in any way shape or form impacting our ability to access the capital markets at a fairly consistent level with where our bonds are trading in the secondary market other than toward new issue premium.
So I don't envision any obstacles. You've seen the reports from the rating agencies in terms of their outlook on the company as a result of the Tropicana/Eldorado transaction and they've made no indication, there's no indication that they'll make any movement in our underlying credit rating at this point in time. And we're going to remain pretty conservative as had always been the case and that goal have never changed.
All in all, the dividend is well covered. Once the acquisitions close, we think they could add up to 10% to the dividend rate from the accretion to the net income. That would move the dividend to ~$2.75 or a current yield on price of 7.81%. This would offset the increase in interest rates and remove that headwind to the price.
We discussed how we want to select investments that are solid-yielding investments but that have some durability during a downturn. Given the late inning we are in the business cycle, we want to ensure that our downside is protected. While the stock would almost assuredly fall in a recessionary environment, we want to ensure that it would be less than the market and that the dividend has a greater chance of remaining stable.
The company's tenant exposure as non-destination oriented is a massive competitive advantage- meaning the typical customer drives less than 2 hours to visit one of their casinos as opposed to a Vegas casino which is mostly reached by plane. During the Financial Crisis, adjusted gaming EBITDA growth among Penn Gaming and Pinnacle Entertainment was far less than their Vegas competition.
Rent coverage also remained well above 1x and fell only marginally from 2007 levels when compared to their Vegas counterparts. In our analysis, this is a key chart and one of the reasons why we are invested in the shares.
This is not a fast-growing stock by any means. We liken it to a high yield non-investment grade bond that has some upside to it (trading under par). The yield is very attractive here and the business less cyclical than most other REITs. The main risk is that casino real estate can really only be used for casinos. Unlike a standalone box that maybe houses a restaurant and can be converted into a Walgreens. If there is a problem fundamentally with the casino industry, it is likely going to effect them all, not just GLPI tenants. If it comes down to it, they may have to sell to another operator who could be going through the same issues.
We value the shares against other triple net leases. At a 11.4x multiple, the shares trade in conjunction with many of the retail REITs and regional mall operators. GLPI still trades at a discount to the specialty REIT sector as a whole with a P/FFO of 11.3x compared to a peer average of 13.7x. Against free standing retail REITs, the shares remain cheap with KIMCO (KIM), another REIT we really like here, at 13.5x, National Retail Properties (NNN) at 16.6x, STOR Capital (STOR) at 13.2x, and diversified REITs like W.P. Carey (WPC) at 13.3x.
The average across the larger market cap triple net lease REITs is approximately 13.9x 2018 AFFO, or nearly two points above GLPI. And yet the gaming industry, we believe, is much more resilient - especially during an economic downturn.
We value the shares on a dividend discount basis using a two-stage model. The 21% dividend growth over a three-year period amounts to just under 7% per year CAGR. Our two-stage model uses a 4.5% high growth for the next four years and then a terminal 3% growth rate. We discounted the cash flows at 9.5%.
That valuation returns a $42 price target for the shares. This is a slight increase in the price target at the start of the year when we were at $40. The valuation variance today isn't the same as the start of the year when the shares were priced in the upper $20s.
Our marketplace service is dedicated to finding opportunities like these as bond-substitutes for our income oriented members. Having bond surrogates that can provide protection in a down market is imperative at this point in the business cycle. As we noted above, GLPI is one of the few REITs that have some degree of insulation against that potential drop.
Remember, they own the hard real estate assets, the casinos themselves which are then operated by someone else. If casino profits fall by 20% in a recession, they're income remains stagnant because they are being paid lease payments, not a share of the house take. With 1.8x rental coverage, casino operations would need to fall substantially before we even need to start questioning the ability of the operator to make their rent payments.
When we hunt for income opportunities across the capital structure (equity, bonds, preferred stocks, exchange traded debt, etc) we want to find these types of opportunities.
Yield Hunting: Alternative Income Opportunities For Retirement
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