Churchill Downs Stock: Racing Along (NASDAQ:CHDN)

In February of this year, I concluded that shares of Churchill Downs (NASDAQ:CHDN) were racing higher as it continued to build out its empire with its announcement of a big acquisition. I have grown much more appreciative of the business over time, as its track record is hard to argue with, yet fear that now is not the time to get involved.

A Quick Recap

Churchill Downs is best known from the Kentucky Derby, but outside its horse racing activities, the company has substantial assets related to casinos and online games as well. Ahead of my take earlier this year, I went back all the way to 2017 when the company divested its Big Fish operations with proceeds effectively used to buy back cheap stock and reinforce the business in other ways.

Shares actually traded around $220 in 2017, the same level as they did earlier this year, but that is misrepresenting the performance as shares have been split on a three-for-one-basis in the meantime. A $882 million business which generated $286 million in EBITDA in 2017 had grown to $1.3 billion in 2019 on which EBITDA came in at $451 million. Earnings per share power had nearly doubled over the same time period, adjusted for the stock-split of course.

Revenues fell to $1.05 billion in 2020, no surprise given the nature of the activities and the impact of the pandemic and related lockdowns, but shares had rallied to $260 early in 2021 already in anticipation of a great year. That has turned out to be reality as revenues were up 58% to $1.23 billion in the first nine months of the year, with earnings coming in at $5.23 per share already, on track to come in around $7 per share.

Net debt stood at $1.65 billion, and with EBITDA trending at $670 million, that worked down to a 2.5 times leverage ratio. The 39 million shares traded at $220 early this year, for an $8.6 billion equity valuation, or $10.2 billion enterprise valuation. This was equivalent to 6-7 times sales, 15 times EBITDA and 30 times earnings, steep multiples by all means

Just ahead of the release of the fourth quarter results for 2021, Churchill announced a $2.48 billion deal to acquire the Peninsula Pacific Entertainment Company, a deal valued at approximately a quarter of its own valuation at the time. With the deal the company would acquire the Colonial Downs Racetrack, more facilities such as casinos and the Hard Rock Hotel & Casino in Sioux City. The 9 time EBITDA multiple was a bit cheaper, as the impact on the bottom line was hard to gauge. Pro forma net debt was seen around $3.8 billion as the company announced a large deal to sell land to Blackstone as well.

I believed that earnings might rise to $9 per share, for a 25 times earnings multiple, yet in combination with nearly 4 times leverage, the valuations were certainly not cheap. Given this high valuation, although accompanied by a strong track record, I concluded to become a buyer in the high hundreds, as the market at large was still much stronger of course, not impacted by rising interest rates yet.

Stagnation

Since my upbeat yet cautious tone in February, shares of Churchill have been trading range bound between $180 and $240 per share, currently exchanging hands right in the middle of this range at $210 per share.

In February, the company posted its full year results with revenues up to $1.60 billion on which $627 million in EBITDA was reported, as well as net earnings of $249 million, equal to $6.35 per share. The company has seen solid growth in the first two quarters of the year, closing on the sale of land to Blackstone and retained earnings ahead of the Peninsula deal, for which the company already secured borrowing well in advance of the deal closing, great timing with the benefit of hindsight.

In October, the company posted third quarter results which revealed a modest year-over-year decline in sales, with earnings per share down eight cents to $1.49 per share, albeit that the EBITDA performance increased a bit. Net debt came in at $1.49 billion ahead of the Peninsula deal, still huge amounts as pro forma net debt would jump to $4.0 billion, albeit that pro forma EBITDA will likely exceed the billion mark following some operational gains seen this year. The deal with Peninsula closed on November 1, so in the fourth quarter, as the real impact of the deal is only seen in the new year of course.

Despite a still elevated leverage situation, the company actually announced another bolt-on, yet substantial deal. The week ahead of Christmas, the company announced a quarter of a billion deal to acquire Exacta Systems, a technology provider of historical horse racing operations, with few details announced on the deal.

Hence, we remain somewhat in the same situation. Earnings are still trending at $7-8 per share in normal conditions (ahead of the Peninsula deal) and leverage is high, in part the result of the continued operational capital expenditures made by the business.

Given the huge increase in interest rates, the debt is more serious than was the case at the start of the year, as overall valuation multiples have come down, which makes that the relative outperformance of Churchill seems to be driven by the long term track record, but it does not necessarily create a nice set-up for potential and perspective investors here. That said, it is too early to write off the shares here as the Peninsula deal might create a roadmap for earnings to trend around $10 per share, but for that a lot of things still have to work out.