Research Notes: Six Weeks In (Part II)
More updates on our work to date
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We continue following up on our work since our launch at the beginning of last month. If you missed Part I of this series, you can find it here. Moving on…
A bit over a month ago, we called out NGMS at $13. The stock closed Thursday at $11.44 after falling 4% during the session, the first following Wednesday afternoon’s Q1 earnings report.
Honestly, there’s little to say. Q1 earnings were fine; NeoGames narrowed its revenue guidance range, but the iLottery provider’s own CEO said on the conference call that “there haven’t been significant changes” since the company’s last call in March.
We are comforted to see Alta Fox Capital, a fund we respect, on the same side of this trade, but that aside our thesis from last month remains essentially unchanged. We liked (and bought) NGMS at $13, we like it more (and may buy some more) below $12.
The Sports Betting Space
Gaming stocks as a whole right now seem to epitomize the challenges of investing in this market. The stocks are cheap, but we have no idea where we are in the macro cycle this year. For the brick-and-mortar companies, there’s a very real question as to where we were last year. Were the companies hurt by the pandemic, or helped by stimulus checks and record levels of household savings and pent-up demand? Obviously, the answer is “both” — but in which direction did the net effect go?
On the online sports betting and iGaming side, the massive amount of promotions distributed skewed market share. Revenue growth looks hugely impressive, but the number of new markets coming online is going to slow. And profitability, for the most part, remains nowhere in sight. As we noted yesterday, DraftKings (DKNG) “beat” expectations with guidance — and still expects EBITDA losses of $760 million to $840 million this year.
All told, like so much of the market, it’s easy to be intrigued by the sector — and easy to stay away from it. But with a big decline in recent weeks, it does seem like there are going to be long-term opportunities there.
Penn National Gaming (PENN) looks like one. The company just raised its full-year profit outlook; it’s repurchasing stock (not a common practice for Penn, though the balance sheet in recent years has been a factor); and the stock is now trading at less than 7x EV/EBITDAR looking to 2022 guidance. That guidance includes zero contribution (actually, a modestly negative contribution) from the Interactive business.
Yet there is so much that can go wrong here. PENN stock is cheap, but there’s financial leverage (~4x lease-adjusted) and operating leverage. A possible recession looms (though current unemployment figures might argue otherwise). Barstool’s share remains minimal; Penn management would argue that’s because it wisely stayed out of the promotional race to the bottom last year (as well as New York state), but whatever the cause Barstool is badly lagging rivals in terms of reach. Roughly the same case could have been made at a higher price; indeed, elsewhere I argued for the stock at $46 earlier this year, and shares closed Thursday at $29.
Long-term, $29 seems too low. Short- and even mid-term, should a recession arise, it may well be too high.
The other intriguing name here is Genius Sports (GENI). We wrote about the silliness of the “picks and shovels” thesis, which supposedly provides a ‘safer’ way to play growing sectors (but never actually seems to work out). GENI — down over 85% from its highs — has shown that silliness, while also contributing to the horrible performance in de-SPACs, about which we wrote yesterday.
That said, there’s still some kind of business here. The online sports betting market is going to grow in the U.S. and worldwide. Even with a huge bounce Friday morning (a seemingly delayed reaction to solid earnings released before the open Thursday), the stock trades at about 11x next year’s EBITDA (admittedly, that’s based on the company’s guidance, which investors rightly may not completely trust).
GENI needs a deeper dive, and some faith. But in a market that resets its expectations for the industry, and has a more reasonable view than it had last year or right now, there seems to be a nice path to triple-digit returns if all works out.
In the case of AppLovin (APP) and NGMS, we’re confident in the long-term outlook; APP’s continued rally on Friday morning seems to support our optimism that the stock is likely to regain a big chunk of its losses in a hurry. (The stock already is +55% or so from its lows.)
For 1-800-Flowers.com, however, the outlook seems notably bleaker. Third quarter results were ugly, resulting in yet another downward revision of full-year guidance and, now, a fundamental profile that looks far less attractive. EV/EBITDA is about 7x, and the stock is trading at about 16x this year’s earnings and normalized free cash flow.
Admittedly, this has been a brutal year, with everything going wrong on the cost side. The balance sheet has taken a manageable hit because FLWS has stockpiled goods: inventory was up $92 million year-over-year, a figure equal to about 14% of market cap, and a rise equal to more than the company’s current net debt position.
And long-term, these kinds of disruptions tend to favor the largest players. 1-800-Flowers.com can manage through this environment and come out the other side; for local florists, and even some of the digital startups trying to take share, that may not be the case.
Still, there’s cyclical risk here with the company’s growing emphasis on gifts; Harry & David is a big part of the business now and a then-independent H&D went bankrupt a few years after the financial crisis. (Private equity debt was a factor to at least some degree.) Even with the stock down ~25% from our call, it does seem like there are higher-upside plays with which to take some of these risks. We are re-evaluating our small position; we’ve been early across the board, but we may simply have been wrong here.
CPaaS Stocks Get Intriguing
In contrast, our look at the CPaaS (communications-platform-as-a-service) sector looks about dead-on. We argued that the space looked like much of tech: intriguing given big drops from the highs, but real danger of further declines going forward. Indeed we closed that article by noting:
But there are seemingly attractive “buy the plunge” cases out there that will get fundamentally-driven investors into trouble, too. We are not out of the weeds, or the woods, by any stretch. That suggests some caution for the long side — and maybe the need for aggressiveness from the short side.
For the space, that’s been true since publication on Apr. 22:
But at this point, the sector is getting interesting. The margin problem we highlighted las month (CPaaS is not SaaS in terms of peak gross or operating margin) is getting priced in. The explosive long-term growth projected for the industry is intact to at least some extent, even if it’s less than originally hoped (owing to lower long-term projections for many of the industry’s customers).
Both CPaaS and adtech (including the aforementioned AppLovin) are sectors where every name could have a big bounce. For investors who think the selling of late has gone too far, those are two good places to start.
We recommended a short of Carvana at $84; even with a big bounce the last two sessions, the stock still is down a little over 50%.
At this point, it’s probably wise to cover. As the past two sessions show, there’s potential for a brutal rally in any kind of bounce (bear market or otherwise). To some extent, the thesis for CVNA was based on it being a prime target for collapsing confidence amid a big market sell-off; we’re less constructive on that sell-off continuing. I’d expect the stock to be a trader’s plaything for at least a few weeks from here; that’s not a game we’re particularly good at.
Procter & Gamble (PG)
In our coverage of large-cap earnings, we suggested a bear spread play on PG stock, though unfortunately we did not put it on. PG stock has fallen a little over 6% in the last few weeks, going pretty much straight down in the process. Resistance once again has held at $165, and it’s difficult in the likely market environment of 2021 to see it giving way.
At $152, PG still looks dangerous — at least dangerous in the context of its profile. The stock still is pricing in rather consistent mid-term growth. Yet there’s a real chance, particularly in terms of foreign exchange, that the next few years are a repeat of P&G’s last decade. That was not a fun decade for PG shareholders, who with the best of timing and with dividends still badly underperformed the market.
We also discussed Coca-Cola (KO), another large-cap consumer name toward which we’re skeptical. KO stock continues to hold up. Perhaps we’re missing something.
The Earnings Losers
Eight days ago, we covered some of the biggest losers from this week’s earnings season. Here’s a list of performance since the May 4 close of names mentioned directly and indirectly:
Teladoc Health (TDOC): -16%
Amazon.com (AMZN): -12%
Accolade (ACCD): flat
Netflix (NFLX): -12%
Chegg (CHGG): -13%
Shopify (SHOP): -19%
The declines aren’t a surprise, particularly with how the market reacted to almost every stock over the following few sessions after we published that piece. But, to beat a dead horse, the declines also are not surprising because none of those names looked particularly compelling after the earnings decline.
But as with the CPaaS and adtech groups, the big earnings losers do look like they’re getting in range. The persistent “you’re getting the retail business for free!” analysis around AMZN doesn’t seem quite right, but at $2200 that stock does seem too cheap. There are simply too many levers to pull there if and when share price appreciation finally becomes a focus for management and the board. The long-term bull cases for the other names (excepting ACCD, which has some real problems) seem relatively intact; the problem to at least some degree was pre-earnings valuation, not actual performance (perhaps TDOC excepted).
If there’s been a theme around our sector and market coverage so far, it’s been one of caution. (We in fact ended our analysis of these big post-earnings sell-offs by explicitly voicing that caution.) Broadly speaking, that sentiment has been correct.
Reviewing those pieces now, however, there seems room for a bit more optimism. We’re not convinced the bottom is in. We wouldn’t be surprised, however, if it’s not that far away.
Nathan’s Famous (NATH) and Quanex Building Products (NX)
Our two most recent ideas, Nathan’s Famous and Quanex Building Products, both have traded flat on no news. In this market, we’ll take it. Each company reports earnings next month — we’ll see what those numbers look like, and what that market looks like. It may well be very different.
As of this writing, Vince Martin has positions in APP, FLWS, NGMS, NATH, and NX. He may initiate a long position in AMZN, PENN and/or GENI in the near future.
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