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Summary
Churchill Downs (NASDAQ:CHDN), owner of the iconic Kentucky Derby, is a diversified gaming operator with a strong historical record. Over the past 3 years, the stock has consolidated while revenue and net income has grown. This has presented investors with a great opportunity to purchase a long-term compounder at a fair price.
Background and History
Churchill Downs is a gaming company, most famously known for hosting the Kentucky Derby—one of the most iconic horse racing events in the world that has been ongoing since 1875. In fact, the next Kentucky Derby, to be held on May 3rd and 4th 2024, will be the 150th edition of the race: a huge milestone. What started as a single racetrack in Louisville in 1875 eventually morphed into a holding company of 7 racetracks in 1928 known as the American Turf Association. In 1950, the American Turf Association dissolved and distributed CHDN stock to shareholders of the American Turf Association.
The company has 3 operating segments:
Live and historical racing: derives revenue from live and historical parimutuel racing revenue at their owned racetracks such as Churchill Downs racetrack in Louisville, Turfway park, Ellis park, and others for a total of 12 live or historical racing venues. Some of these venues include live horse races, while others function more like casinos with machines known as (HRMs) Historical Racing Machines whose outcome is based on historically run races. Some venues include both live racing and an HRM facility. Live and Historical Racing is responsible for 42.5% of revenue and 43% of Adjusted EBITDA.
TwinSpires: this is the company’s online horse wagering business, which derives revenue from online betting as well as from providing horse racing statistical data to other betting platforms such as DraftKings' (DKNG) DK Horse. While it can be conceived of as a niche version of an online betting app, TwinSpires is actually profitable, unlike other betting apps such as PENN’s ESPNBet or CZR’s betting app. The TwinSpires segment is responsible for 18.6% of revenue and 12% of Adjusted EBITDA.
Gaming: derives revenue from slot machines, table games, hotel revenue, and HRM revenue located at properties best understood as classic casinos. Churchill Downs wholly owns 10 casinos, such as Calder Casino in Florida and Hard Rock Hotel and Casino in Iowa. They also have equity stakes in 2 other casinos. Gaming is responsible for 39% of revenue and 44.6% of adjusted EBITDA.
The Stellar Historical Record
Churchill Downs has a strong history of revenue growth and value creation. Through both organic investments in its properties and a steady rate of acquisitions, Churchill Downs has managed to grow revenue at a CAGR of 12.55% over the past 14 years.
Churchill Downs 14 Year Revenue Growth (Macrotrends.net)
Revenue growth without operating income or earnings growth is value-destructive, so we must look at Churchill Downs' record of EPS and operating income growth over that 14-year period. Remarkably, EPS over the same 14-year period has grown from $0.20 to $5.50 for a CAGR of 26.7%. Operating Income has grown at the same rate as EPS.
Churchill Downs 14 Year EPS Growth (Macrotrends.net)
By combining this picture of revenue growth and EPS growth, one can see that CHDN has been successful in creating value in its operations and creating operating leverage within its business. Its stock has reacted accordingly by appreciating at a superb rate of 23.8% per year over that past 14 years, handily beating the S&P500.
Churchill Downs Overall Return 14 Year (2010 - 2024) (dividendchannel.com/drip-returns-calculator/)
Stagnation Since 2021
However, despite this stellar long-term record, the stock price is little changed since March 2021 and has lagged the S&P since that time. Is there a mispricing here, or has Churchill Downs' best days past us already? The past record is indeed strong, but the stock price will only go up if the future record is similarly as strong and the price paid for the stock is reasonable. I will now examine these points.
Since 2021, Revenue has grown from $1.45 billion to $2.46 billion for a CAGR of 20% over 3 years.
Operating Income has grown from $246 million to $564 million for a CAGR of 30% (EPS has grown at a similar rate) showing that CHDN is still generating operating leverage and creating value.
Since the stock price has not grown over this 3-year period despite revenue and operating income/EPS growth, the P/S multiple has contracted from a record high of 5.36 in 2021 to 3.84 currently. The P/E multiple has contracted from 30.4 to a more reasonable 23.5.
While the stock price is much more attractive now than it was 3 years ago, my calculations so-far do not point at the future return, as Churchill Downs must continue to generate future revenue and operating income growth for the stock price to advance.
Looking at the 10-K gives reason to be optimistic about future prospects. Specifically, I will discuss the investments the company is making in each of their 3 operating segments in order to drive future revenue and earnings growth.
Within Live and Historical Racing, they are investing $214 million in the Kentucky Derby venue to enhance the event experience with the new Paddock Experience, which includes 2 new clubs for guests to view horses and enjoy the Kentucky Derby. This will debut at the 2024 Kentucky Derby and can help drive future pricing power. They are also investing $560 million to open 2 new HRM venues: The Rose (Dumfries) and the Owensboro.
Within TwinSpires, Churchill Downs has recently signed agreements with DraftKings (DKNG) and FanDuel (FLUT) to give them access to statistical data as well as live feeds of horse races. Additionally, it has completed a sale of 49% of its United Tote business, which is contained within the TwinSpires operating segment, to the New York Racing Association (NYRA).
Within Gaming, the company states it owns 15–20 acres in Florida near the Calder Casino that it can sell or maintain for future development. In addition, It has invested $290 million to open a new casino in Indiana: the Terre Haute Casino Resort.
Thus, with recent expenditures of near $1 billion into enhancing the Kentucky Derby experience, opening new HRM venues, and building a new casino, Churchill Downs has ample room to drive growth over the next 5 to 10 years.
Additionally, since 2013 shares outstanding have decreased 30% and Churchill Downs pays a small, but consistent and growing dividend, which they have maintained over 13 years with a growth of 7.05% annually. It currently yields 0.30% with just a 7.5% payout ratio--ample room for growth.
An Aside About Their Debt and Balance sheet
Churchill Downs does not have the cleanest balance sheet as they have a high debt load of around $4.8 billion, which led to a $268 million interest expense in 2023. This corresponded to almost 50% of their operating income.
In the most recent Q1 2024 earnings call, management addressed the issue, by mentioning their goal is to keep leverage between 3-4x Adjusted EBITDA. Last year, Adjusted EBITDA was $1.024 billion, which corresponds to a 4.7x ratio and is higher than management’s goal. They implied that leverage should decrease over the year and monitoring for balance sheet improvement will be key. Additionally, Adjusted EBITDA can include miscellaneous items that make it look better than it actually is, but Churchill Down's EBITDA is equal to 97.5% of Adjusted EBITDA, meaning that there are not many additions.
The company has no near term maturities with the closest maturity being $600 million of 2027 notes, which bear an interest rate of 5.5%, and they also have a $1.235 billion of their Term Loan A due in 2027, which bears an interest rate of SOFR + 10 bp, currently equal to 5.4%.
Despite the high debt load, I believe the proven earnings power and cash generating ability of Churchill Downs will allow them to responsibly manage their debt over time and do not see their debt load as a major risk to the company in the near term.
Expected Value of the Company
Considering the historical record and taking into account management’s ongoing investments in growth, I have modeled an estimate of what their future earnings growth looks like using the GuruFocus Earnings calculator.
GuruFocus Earnings Calculator (Gurufocus.com)
I have modeled the company’s growth to decelerate from its historical growth rate of 26% to 12% considering the larger market cap base and maturity of the company, which makes growth more difficult. However, I consider this deceleration to have baked in a large margin of safety as Churchill Downs has shown the ability to grow at a strong rate over the past 15 years and should continue to do so considering there multiples avenues of growth.
Based on my calculation, Churchill downs is 17% undervalued.
Peer Analysis
Churchill Downs is unique in that it owns an iconic asset in the Churchill Downs racetrack and rights to the Kentucky Derby, in addition to an online betting platform and traditional casino operations. This diversified operation differentiates it from peers, which either own purely casino operations or are pure play online sports betting operators.
Compared to peers, CHDN is more expensive than legacy casino operators such as CZR, PENN, and WYNN, and less expensive than online pure play operators such as DKNG.
Peer Analysis (Valuation) (SeekingAlpha.com)
I believe the premium valuation is justified as Churchill Downs has been able to generate superior revenue growth and more consistently converts that revenue into EBITDA compared to peers. The exception is DKNG, which is growing much faster, but is also almost 4x more expensive on a EV/EBITDA basis.
Peer Analysis (Growth) (SeekingAlpha.com)
Finally, a look at profitability shows that despite a lower gross profit margin, Churchill Downs has best in class net income margins, suggesting that management is skilled in controlling operating expenses. The best-in-class return on equity and return on capital supports that idea.
Peer Analysis (Profitability) (SeekingAlpha.com)
Considering the diversified nature of Churchill Downs' operations, the strong revenue growth and profitability metrics, I believe CHDN is a good candidate within its sector and can outperform the general market over the long term. The recent 3 years of consolidation, which have led to multiple compression as revenue and income have grown, has given investors a great opportunity to invest in Churchill Downs.
Risks
There are several risks to my thesis. Another pandemic such as COVID or a calamity that causes live entertainment venues to shut down would impact Churchill Downs as the Kentucky Derby is a major contributor to its financial performance and a lack of ticket sales would be impactful.
Gambling is inherently a controversial area, both politically and culturally. Irresponsible gambling can destroy lives and if there is a crackdown on gambling or Churchill Downs is prevented from expanding its operations in the future, this will impact their financial performance. Many investors may not consider gambling an ESG-positive sector and so investors may avoid the company, leading to further multiple compression.
The Kentucky Derby is a cultural phenomenon that has years of reputational goodwill built up and negative developments such as the death of 12 horses last year over a 1-month period at the Churchill Downs racetrack can lead to reputational risk or regulatory problems that may impact financial performance.
Conclusion
In conclusion, Churchill Downs is a best-in-class gaming operator with a unique asset in the Kentucky Derby and Churchill Downs racetrack. Its excellent historical record coupled with its recent investments in growth should continue to fuel revenue and income growth over the medium to long term. Its stock price has consolidated over 3 years, presenting investors with a good opportunity to own a proven long-term compounder at a fair price.
