Downside risks to gaming stocks to start 2025, but opportunities in igaming and online sports betting

Friday, December 27, 2024 3:00 PM
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  • Buck Wargo, CDC Gaming

J.P. Morgan analyst Joseph Greff called 2024 a down year for the gaming industry’s share-price performance and called out some downside risks for Las Vegas to start the year. However, he balanced that with upside for igaming and online sports betting operators.

In terms of rating changes, J.P. Morgan in a note to investors upgraded Penn Entertainment and GLPI to Overweight from Neutral. Their top picks are DraftKings for online sports betting and igaming growth and Las Vegas Sands benefitting from Macau.

For the Las Vegas Strip and locals gaming, Greff said MGM Resorts International, Caesars Entertainment, Red Rock Resorts, and Boyd Entertainment face “more downside risk to stubbornly high-consensus estimates than upside, without a full appreciation for slowing top-line growth and the ensuing margin impact. This is not a great dynamic for share price upside in the near term and note the difficult year-over-year comparisons through the first quarter.”

At the same time, Greff doesn’t see “a great dynamic to be massively negative for any period of time either. While we see a lack of near-term fundamental catalysts for Las Vegas operators, we see value in shares and solid medium-term risk/reward.”

In Macau, Greff sees attractive growth of mid- to high-single-digit gross gaming revenue growth in 2025, relatively inexpensive valuations, and the potential for improving investor sentiment. Morgan is encouraged by the National Immigration Administration of China’s recent announcement to improve tourism to Hong Kong and Macau, allowing multi-entry visas for residents in neighboring cities.

Starting in January 2025, Zhuhai residents can apply for a visa that allows one visit to Macau per week within a year, with each stay no longer than seven days. Hengqin residents can apply for a multi-entry visa that allows unlimited trips to Macau within one year, with each stay no longer than seven days.

“We believe this should aid the base and grind mass segment, which has lagged the relatively solid recovery of the premium mass segment,” Greff said. “For the Macau names, we think Las Vegas Sands has a reason for more positively inflecting fundamentals with a lack of disruption and ensuing revenue and EBITDA growth from very soon to be entirely completed Londoner renovations, and the solid momentum from Marina Bay Sands in Singapore.”

Greff sees Macau operators Wynn Resorts and Melco Resorts & Entertainment lagging Sand’s 2025 growth.

Looking ahead to 2025, the most attractive growth within gaming is North American online sports betting and igaming.

“We see meaningful growth and continued upside to total addressable market estimates in 2025 and into out-year periods,” Greff said “They’re benefiting from higher engagement, retention, and monetization from improved and expanded product offerings such as more comprehensive parlay capabilities, an expanding in-game betting mix, and continued customer acquisition momentum in newer states and through increased population penetration in existing states.”

While higher tax rates have been a key investor topic since Illinois proposed a tax hike on operators on July 1, Greff “doesn’t ascribe a high probability to a widespread tax hike on operator GGR, given minimal momentum for the now-dead bills introduced in Massachusetts and New Jersey. In any event, we would view the most scaled operators as best positioned to navigate and mitigate the impact of any future regulatory changes.”

For 2025, Greff forecasts nearly 20% same-state combined online sports betting and igaming revenue growth, complemented by an incremental 2% of the population going live with legal online sports betting. That only contemplates Missouri launching at some point in 2025 and no new igaming states.

Growth assumptions are balanced between online sports betting (+20% year-over-year) and igaming (+18% year-over year), Greff said. Longer-term, they forecast U.S. and Ontario sports betting and igaming revenue to reach $42.1 billion by 2030 with sports betting at $26 billion and igaming at $16.1 billion.

“That represents a 10% ’24-’30 CAGR (10% compound annual growth for both sports betting and igaming),” Greff said. “Our longer-term estimates imply 7% and 8% compound annual growth for existing states sports betting and igaming GGR complemented by about $500 million of incremental sports betting GGR annually from new states (assuming about 3% of the population gains access to legal online sports betting) and about $325 million of incremental igaming GGR annually from new states.”

That assumes about 1% of the population gains access to legal igaming starting in 2026.

In upgrading Penn to Overweight with a $27 2025 year-end price target, Greff said they see “a favorable risk-reward, with sightline to a bottoming of its regional land-based-casino cash flow generation.” There’s a path to aggregate growth, given $850 million of investments into its four retail growth projects “beginning to bear fruit and ultimately generating attractive double-digit cash-on-cash returns” beginning in the second half of 2025 and later into 2026, he added.

“In addition, we see reasonably set expectations for near-term Interactive online sports betting and igaming losses for the fourth quarter of 2024 and 2025 with buy-side expectations for modestly positive EBITDA generation in 2026,” Greff said. “We have long-held the view that some degree of ESPN BET success is the single biggest driver for the stock and still see that as the case, but we see a scenario of modestly positive segment EBITDA in 2026 as not priced in the shares, and importantly, is not that much more than Penn’s estimated annual market access fees.”

Greff called this “noteworthy,” because if Penn is less than successful in interactive profitability, “the company simply could/would shut it down and milk the $60 milion-ish of market access fees in our view. And in this scenario, one where ESPN BET isn’t successful for competitive or other reasons, we see the value of land-based casino and market access fees equating to $26 per share.”

Also in this scenario, Greff said additional changes such as asset sales, levered recap, and mergers and acquisitions would likely elevate the floor in the stock.

“So net-net, we see a favorable fundamentally driven risk-reward given improving free cash flow as a result of land-based casino capex dropping dramatically in 2026, its ability to deploy FCF to de-lever and reduce its not so burdensome cash interest expense and shrinking Interactive losses. On what we think is a reasonable base case assumption embedded in our 2026 forecasts, Penn is generating $525 million in discretionary free cash flow (EBITDAR less rent, cash interest, cash taxes, and maintenance capex) or $3.14 per share, equating to an attractive mid-teens free cash flow yield at current share price.”

Greff noted the share price of Penn has “meaningfully” underperformed both its peers and the S&P 500 by an average of 45% for each of the last four years.

In upgrading GLPI to Overweight, Greff said they’re raising their year-end 2025 price target to $54 from $49. Given recent year-to-date share-price underperformance versus the S&P 500 and its GNL universe, “a safe and healthy” 6% dividend yield, built-in growth from rent escalators, recent/pending mergers and acquisitions’ driven growth “provide for attractive visibility and a predictable business model with far less volatility compared to lodging REITS or Gaming OpCos. We also can’t help but think that a lower interest rate environment will lead to incremental M&A, giving GLPI potential additional inorganic growth opportunities.”

As for reaffirming its Overweight rating for DraftKings, Greff said they’ve raised their year-end 2025 price target to $53 from $47. They highlight DraftKings as the “pure-play in the most attractive growth market in gaming and continue to believe that DraftKings has an attractive revenue growth profile and an ability to leverage its scale and strong competitive position in the U.S.”

Online sports betting and igaming markets should realize operating-expense rationalization that generates improved margins, EBITDA, and free cash flow streams, Greff said.

For 2025 and 2026, Morgan forecasts revenue of $6.4 billion and $7.26 billion, implying 31% and 13% year-over-year growth. They forecast adjusted EBITDA of $950 million and $1.46 billion, implying margins of 15% and 20%), respectively, and “importantly we don’t see its 2028 financial targets or consensus 2026 revenue growth forecasts (+17%) as overly aggressive, with similarly achievable margin upside. We see DraftKings as a direct beneficiary of attractive same-store and new market growth prospects against the backdrop of an industry-wide improving operating expense control environment, with competitive strengths from its superior product capabilities, and customer acquisition competencies. It’s scale has allowed it to compete against new entrants like ESPN BET and Fanatics, much like it has successfully competed in the past with newer entrants.”

In reaffirming its Overweight rating for Las Vegas Sands, J.P. Morgan raised its year-end 2025 price target to $62 from $60.

“We remain confident/optimistic that in Macau, LVS’s Londoner renovation disruption will meaningfully abate from here, which should allow the company to achieve above-Macau-peer EBITDA growth in 2025,” Greff said.
“We model about $2.8 billion of Macau property-level EBITDA or 16% year-over-year growth. We presently view buy-side expectations as reasonable with steady $400 million to $500 million of quarterly share buybacks and a still attractive Singapore market (about 9% growth in 2025, following 13% growth in 2024) and longer-term growth coming from capex/expansion their (integrated resort 2 project).”