If you have ever been to a casino, you know just how opulent and exciting they can be. It is very easy to get taken in by their atmosphere, which is one of the reasons casinos are heavily regulated. Regulation, meanwhile, has an important impact on industry players like Penn Entertainment (PENN -0.05%). Here's why some regions of the country are far more friendly to the company's finances than others.
There's a lot money changing hands
From a basic perspective, casinos are a risky place for consumers. The games are designed so that the house tends to win. Free-flowing alcohol, and the often detrimental effect that has on human judgment, worsen the odds further.
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There's little wonder, then, that companies like Penn Entertainment face material regulation. But there's another angle to the story. Casinos generate a lot of money. It is hard for the government to look at the cash being generated without trying to get at least some of it for the use of the state. So not only is there material regulation of casinos, but that regulation includes often heavy taxes.
This is why Penn Entertainment's fiscal first-quarter 2023 earnings presentation contained this quote: "Strong performance in our Northeast Segment mostly offset softer y/y results in the South Segment, while margins were impacted by approximately 100 bps from a shift in revenue to higher tax jurisdictions and, to a lesser extent, the settlement of certain litigation matters."
Lower taxes lead to higher profit margins
There's a little bit to digest here. For starters, Penn Entertainment's Northeast business did well while the South did less well. The bigger takeaway is that this dynamic resulted in weaker profit margins. Why? Because of tax differences between the Northeast and the South. The numbers are pretty telling.
The gaming tax rate in Penn Entertainment's Northeast operations in the fiscal first quarter was a huge 41.8%. That was the highest of any region in which it operates. That pressure left property-level margins in this division at 30.4%, lower than for any other region. So while it is good news that the Northeast performed well, the benefit to the company isn't as great in other areas.
The South had a tax rate of 22.3% with margins of 39.3%. That's the second-highest margin in the company's business, so a weaker showing here in the quarter was a notable headwind.
To round out Penn Entertainment's business story, however, there's still a bit more you need to know. The Midwest region had a tax rate of 26.8% and margins of 42.5%, the highest in the quarter. The West had a tax rate of 18.3% and a margin of 37.9%. The tax rate in the West is lower, and thus better for Penn Entertainment, than in other geographic regions.
A more complicated story
When you dig in and look at the fine details, Penn Entertainment's business is a bit more complicated than it might at first seem. And while you may not be thinking about the regulation and taxation of casinos while you are at one of the company's tables, it is a very big deal when it comes to understanding the company from an investment standpoint. The fiscal first quarter shows how important that is, given that the mix among the regions reduced the company's margins by a full percentage point. If you own Penn Entertainment, you should be rooting for the West, which has the best taxation rates for this casino operator.
