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Pinnacle Entertainment’s use of capital

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Capital employment

Casino companies fund their acquisitions with a significant amount of debt capital. ROIC (return on invested capital) is an important metric that shows how effectively a company makes use of its capital.

To calculate ROIC, divide EBIT (earnings before interest and tax) by the employed capital. A higher ratio denotes that more profit dollars are being generated by each dollar of capital being used.

A company’s ROIC should be higher than its WACC (weighted average cost of capital). Otherwise, the company may not be employing its capital effectively.

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The graph above shows that the ROIC for Pinnacle Entertainment (PNK) has been lower than the company’s WACC for the last three years. The most important thing to note is that PNK’s ROIC has declined from over 6% to around -4% since November 2012. PNK has a debt burden of roughly $3.98 billion relative to equity value of around $259.6 million in its capital structure as of September 30, 2014.

ROIC usefulness

ROIC is useful for companies in the capital-intensive casino industry. Unlike ROE (return on equity), which only analyzes profitability related to a company’s equity capital, ROIC captures the effect of debt capital as well. This provides a better indication of financial performance for Caesars Entertainment (CZR), Boyd Gaming (BYD), Isle of Capri Casinos (ISLE), and other companies with capital structure leverage in excess of 70%.

Pinnacle Entertainment, Caesars Entertainment, Boyd Gaming, and Isle of Capri Casinos are components of ETFs like VanEck Vectors Gaming (BJK).

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