Churchill Downs: Strong-Performing Gaming Stocks Avoid CHDN EBITDA Growth Measure

Above: Reversing a 60-year trend, CHDN’s investments in racing revival have contributed to the revival of thoroughbred racing.

We watched the stocks to Churchill Downs Incorporated (Nasdaq: chdn) for seven years since June 2017, when it traded at $57.10. In the first months after Covid-21, the price moved to $114.78. At the time of writing, the price has risen to $135 today. This has been a great ride for long time holders. CHDN has been trading at over $100 since 21. The rationale has been built on the continued strong performance of this niche gaming operator in generating accelerating profits from what is essentially a small footprint in the overall gambling sector.

Above: Slow and steady winning the dividend race over 12+ years.

CHDN achieved Consistent growth in revenue and net income over more than a decade from three business units: live and historic racing from 12 tracks, including its namesake Churchill Downs track, home of the Kentucky Derby. The unit produces more than 42% of total annual revenues.

Twin Spires—The company’s online race betting site, which also has a B2B data feed deal with two industry leaders, DraftKings (DKNG) and FanDuel (FLUT). Two years ago, management shut down its entire sports betting business, believing it could not generate returns that matched costs as well as intense competition from as many as 15 sites.

They therefore ceased to take any action in all sports, except in the familiar field of horse-racing. Add to this its B2B data business, and TS today represents approximately 19% of total group revenue and 12% of Adj. EBITDA. It proved to be a great decision, an expression of the company’s strategy, and the best description Like knowing when to carry it and knowing when to fold it. More on this later.

Gaming: The company owns 10 casinos in the United States and has positions in 22 other casinos that rent its historic racing machines. (FYI: HRMs are slot machines with video screens that replay unspecified horse races from a vast film and video library delving into history on which players can place various bets. They were once a staple of most Nevada casino floors that are dead. But CHDN revived it with updated graphics and features with great success.)

Its casino business is mostly cited in metro areas away from the daily head-to-head revenue fight with major operations. This insulates it to some extent from the high marketing costs resulting from direct exposure to large-scale properties. It represents 39% of revenue and approximately 45% of Adj. EBITDA. Its revenue growth has been moving at a CAGR of 12.55% over more than a decade.

Above: Fair value is a modest rise above trading compared to bull, but CHDN is closer to full value because its largest holders are long drawn.

CHDN revenue growth

Pre-Covid 2019: $1.33 billion

2024E: $2.72 billion

Pro: 2024: $3 billion

E24 Earnings: $6.09 – P/E 22.08 per year 23+10%+

Prevailing growth pace until 2026: $8 – P/E 15.60

Return rate: $0.38 or 7.49%

Market value: $9.89 billion

Enterprise value: $14.6 billion

Trading volume: (3 months) 477,537.

Outstanding shares: 73.5 million, 72% of which are owned by institutions. Here’s the story: CHDN is a diversified, savvy capital allocator with proven skills in both acquisitions and dispositions of companies it has bought with high hopes of building revenues and diversifying its products.

A good example of this is CHDN’s $885 million purchase in 2014 of Seattle-based social media company Big Fish. Lots of happy rhetoric from CHDN went into the deal. The company saw its pivot into the hot segment as a major growth move with more to come. But it didn’t take long for the Seattle brothers’ work culture to clash with the CHDN belt and the pros across several strategic decisions.

There were other reasons, of course, but mainly it was a result without potential. In 2017, CHDN saw that the writing on the financial wall was unhelpful, so it sold Big Fish to Australian Aristocrat for $990 million, pocketing $150 million in the process. (Big Fish’s revenue today is about $270 million.)

There are other invasions that CHDN has acquired or eliminated along the way. We cite them to reinforce our conviction that the company, with its status far from the center of big moves in the gaming industry, has shown wisdom in accumulating assets that have delivered results. As such, it has earned a place in the hearts of its owners that remains to this day. It’s clear that CHDN’s stock price history is also, in large part, a product of its relatively small common stock.

There is no doubt that the company can become more aggressive by looking at several sectoral moves to accelerate its growth through a more expansive lending program for acquisitions. But it is clear that management has chosen to keep the company in a safe zone where it does not encounter competitive pressures for growth, leading it to uncomfortable pastures. I think it’s unfair to characterize CHDN’s management as content to fill its somewhat low-visibility domestic niche as a solid performing company with a stable board and a shareholder group that is happy with the progress it’s making.

CHDN’s EV-to-EBITDA ratio of 18 at 12/23 is roughly double what most analysts think is a “healthy” 10. But one factor here stems from its debt profile. The company is sitting on $4.93 billion in debt, mostly due to an aggressive capital expenditures policy of spending on acquisitions like a new Terre Haute property in Indiana and expanding its historic horse racing population. Its small circulation volume not only stems from its distinct small size, but its long-time holders are a happy tribe. Relatively speaking, its cash position of $149m is a bit small compared to its debt. Its leverage at writing is 5.96, which is high but manageable. But in a recent earnings call, management indicated that if given the opportunity, it wouldn’t hesitate to increase leverage if the promise ahead was truly enticing.

We find this generally positive. Its track record of producing EBITDA when expanding or acquiring is sound. His track record of earnings growth demonstrates his savvy choices and abandoning poor returns on investment quickly. So, is this a case for the stock at $135, which is the general range it has inhabited for years? Earnings growth will continue unabated from its strategy of being a big man in a smaller pond with an eagle always open to smart opportunities.

Landmarks ahead for investors

From a pure analysis of CHDN stock performance over the past decade, we see a strong bullish case from investors happy with the yield, confident that growth will be organic and through deal making. When so many large holders have been around for a long time, it is difficult to conclude that the downside risk is so low that the return will justify holding the position.

What’s puzzling over for CHDN is whether entering the second decade since 2000, the company’s narrow, but effective, view of its future suggests it’s a healthy rocking chair stock and not for investors looking for big returns on stocks betting with bigger eyes ahead?

We look at shares of Flutter Entertainment (FLUT), the parent company of online industry leader FanDuel. At the time of writing, the stock price was $191.55 driven by its dominant 47% share of the US sports betting market, and its turnaround is expected to be profitable. Today’s PT Consensus Analyst shows a 36% upside for FLUT based on revenue growth, broad earnings gains and an expected revenue of $11.7 billion this year from its U.S. and global businesses.

The average analyst PT for CHDN stock is $148, a bullish rating of 10% versus 36% for FLUT. Undoubtedly, both stocks have strong buying justifications for different reasons. FLUT will participate in the double-digit growth of sports betting until the sector reaches $30 billion in annual revenue by 2030.

CHDN will have to make a quantum leap that combines issuing more stock, hitting a split, or borrowing heavily to scale its current $3 billion annual revenue and EPS performance way above its current footprint. Its real-world growth barring a merger or acquisition would be impressive, but incremental. They’ve invested heavily, bringing great new feature space to the parent track. But you can only add so many bells and whistles until the audience starts saying, I’ve been there, I’ve done that.

So investors need to examine whether their overall strategy has room for a top-tier rocking chair stock or a big rally like FLUT that could come once it has sustained earnings. Keeping both in a balanced gaming portfolio isn’t a bad idea either. You have a low-risk return of 7% or more, efficient and proven management, and a long-term conviction that it will continue as a reliable producer of growing profits year after year.