Churchill Downs Incorporated

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Churchill Downs Incorporated (CHDN) is a gaming and entertainment company, best known for its iconic Kentucky Derby horse race, but now a diversified hospitality and entertainment company with investments in gaming and race tracks.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Churchill Downs Incorporated (CHDN) operates a diversified portfolio of gaming, racing, and entertainment businesses. Here’s a breakdown of its operations:

  • Live and Historical Racing: This segment includes Churchill Downs Racetrack in Louisville, Kentucky, which hosts the Kentucky Derby. It also operates other race tracks in various states and online sports betting. Revenue is generated through pari-mutuel wagering, simulcasting fees, and event admissions.
  • Churchill Downs’ iconic Kentucky Derby, which has been running for 150 years, provides some brand recognition and history to the brand.
  • Gaming: This segment focuses on casino gaming operations, which typically include slots and table games. The company has both physical casinos and also operates online casinos and sports betting. This segment generates revenue from wagering, food and beverage sales, and other amenities within the gaming facility.
  • TwinSpires: This segment includes the company’s online wagering business, primarily focused on horse racing. A large portion of the revenue is related to customers betting on their different racing properties and also provides online sports betting.
  • All Other: Other investments and corporate expenses.

The company’s core business revolves around live horse racing and its iconic Kentucky Derby event, which attracts substantial visitor volume, leading to higher revenue from betting, media rights, advertising, and on-site spending. However, recent growth in the gaming and entertainment sector has been prioritized.

The pandemic led to dramatic shifts in customer behavior, accelerating online growth and creating an uncertain future for brick-and-mortar entertainment.

  • The gaming industry has been undergoing substantial consolidation with major firms taking over smaller firms to improve operations, cut costs, and improve market share.
  • The trend of online gaming, sports betting, and online gambling is also accelerating and taking market share away from brick and mortar casinos.
  • There is also a trend of rising regulatory and social restrictions on gambling activities, requiring more management effort to stay on the positive side of regulations.
  • The industry trends include greater emphasis on consumer experience and innovative offerings to attract and retain customers.

The trends in the gaming industry point towards the importance of online gambling, digital infrastructure, technology and entertainment integration, and operational efficiency, which may be difficult for the company.

Competitive Landscape

CHDN faces competition from a variety of players:

  • Other Race Tracks & Casino Operators: Numerous regional and national casinos and horse tracks compete with CHDN, including MGM, Caesars, Boyd Gaming, and Penn Entertainment. This competition is particularly intense in areas where these companies operate brick-and-mortar businesses.
  • Online Gaming & Sports Betting: The rapid rise of online gaming platforms has increased competition with companies like DraftKings, FanDuel, and BetMGM leading the way in online sports betting and online casinos. Competition is increasing as more jurisdictions legalize online gaming.
  • Entertainment Businesses: Traditional entertainment options like live events, movie theaters, and amusement parks also compete with CHDN for consumer spending.

These multiple competitors are creating strong competition, resulting in pricing pressures and eroding potential market share.

What Makes CHDN Different

  • Historical Significance: The Kentucky Derby is a globally recognized sporting event with a strong brand reputation and significant media recognition. This gives Churchill Downs a unique cultural significance that is hard to replicate.
  • Diversified Revenue Streams: They operate across multiple streams including live racing, online sports betting and casinos.
  • Online Wagering Platform: TwinSpires is a strong business with high customer stickiness because it provides a unique wagering experience focused on horse-racing.

Financials

Here’s a closer look at CHDN’s financial health, based on recent reports and calls:

  • Revenue Distribution: CHDN’s revenue comes from different segments. While the live horse racing and historical racing segments used to represent most of the revenue, today a growing segment comes from the gaming and online wagering businesses.
  • Operating Margins: Recent results show that the operating margins have been under pressure due to high competition, high marketing expenses, and increase in expenses across the board. While previously having higher margins, the margins appear to be declining, with growth now primarily stemming from operations in the gaming space.
  • The latest earnings call highlighted significant growth in sports betting segment, but at a cost. It appears like the management is having difficulty balancing growth and returns.
  • Capital Allocation: Historically the company has allocated capital towards acquisitions that have expanded its regional footprint. Most acquisitions have been at the level of small casinos and racetracks, leading to organic growth in cash flow and revenues. Lately, they have been investing and allocating more cash into the business.
  • Debt and Leveraging: Churchill Downs continues to leverage its balance sheet to fund growth and acquisitions. Although leverage has provided more returns in the past, it is important to see how management handles the changing financial conditions and rising interest rates.

Moat Analysis

Based on the analysis above, CHDN has a Narrow Moat (2/5). Here’s why:

  • Brand Recognition (Partially Wide): The Kentucky Derby has strong brand recognition and a long-standing history. This gives CHDN a significant advantage, similar to a brand moat. However, most of the brand strength comes from one specific event and a single geographic location.

This limits the overall effect of the company’s brand moat. Other parts of their business like gaming and online betting are still relatively new and without an established brand.

  • Switching Costs (Limited): There is evidence of customer loyalty in their TwinSpires business, but the nature of the industry doesn’t generally allow for the creation of significant switching costs. Also, while customers may be loyal to the Kentucky Derby, they could easily go to another company’s brick and mortar casinos, or even use another online gambling app.

The company needs to create more loyalty within the casinos and entertainment sector to give their business a stable revenue stream. * Scale Advantage (Limited): The company benefits from some scale in its live horse racing properties and related operations as it has some of the best horse racing tracks in the country, but faces steep competition in the broader gaming industry. Their strong cash flow from the racing segment does allow them to compete more aggressively against other gambling firms. * Intangible Assets (Limited): Regulatory licenses help to protect specific segments of CHDN’s gaming operations, creating some sort of moat in states where they operate. But this moat may become challenged in case of changing regulatory requirements or increasing number of licenses.

The competitive advantage arising from regulations are more susceptible to change.

Overall, CHDN’s moat is limited. Its dependence on a single iconic event and the relatively new areas in which it operates make its current advantages weak. Their moat is vulnerable to competition and changes in regulatory landscape.

Risks to the Moat and Business Resilience

  • Regulatory Risk: A major risk for the company is regulation and any change in the regulations surrounding gambling and racing. A large percentage of its operations require government approvals, and any policy change can drastically impact revenue and profitability.

For example, the legalization of online sports betting in more areas is increasing competition. But any adverse regulation could impact their operations in states where it currently enjoys favorable regulatory conditions.

  • Economic Cycles: The company is vulnerable to economic downturns which can reduce discretionary spending, impacting their revenues from both gaming and live horse racing.

In the case of recession, customer spending tends to decline dramatically, impacting revenue across the board.

  • Competition: Increased competition in online betting and the casino sector might erode their market share and squeeze margins.

The gaming industry is currently consolidating, with major players aggressively growing in scale. Smaller firms have found it hard to compete in this changing landscape.

  • Technological Disruption: Emerging technologies or alternative forms of entertainment can alter current consumer preferences, impacting the existing business.

The rise of online gaming companies is a good example of this risk.

  • Loss of Key Events: The loss or diminished success of major events like the Kentucky Derby could have a significantly negative impact on its financials.
  • Geographic Risk: Revenue is heavily dependent on certain areas of the USA, meaning a negative event in any specific area can cause revenue declines.

Despite these risks, CHDN demonstrates a level of resilience through its well-established brands and diversified revenue streams. The company is also rapidly expanding its online gambling and sports betting segments, giving it an option for growth, despite uncertainty within other business streams.

Understandability

CHDN’s business model is moderately complex as it involves multiple segments including racing, casinos and online sports wagering. They also operate in many different jurisdictions, all with specific rules and regulations. Their financials are also moderately complex, given the effects of acquisitions and consolidation, and the various ways different revenues are recognized. Therefore, a 3/5 seems like an appropriate understandability rating.

Balance Sheet Health

CHDN has a moderately healthy balance sheet but seems to be increasing leverage.

The company has ample liquidity and good asset base, but has a good amount of debt, which is common for capital-intensive businesses like these. * Current ratio has been historically good, but some recent debt increases have increased the risks.

  • It appears they have enough resources to meet near-term obligations and also significant liquid assets. However, further monitoring is needed to ensure that debt levels don’t become unmanageable. Thus, CHDN receives a 4/5 rating on balance sheet health.

Recent Concerns and Management’s Stance

  • Acquisition-Based Growth: Although the company has been growing, their primary strategy of mergers and acquisitions has been questioned by many. They have acquired many regional players, but haven’t generated significant cost synergies.
  • Management acknowledges the market concerns regarding the strategy, and are now looking to improve profitability by cost cutting and improving existing business operations.
  • Rising Expenses and Falling Margins: The company’s latest results show lower earnings, lower EBITDA, and lower ROIC due to rising expenses and lower margins.
  • The management has acknowledged these issues, pointing towards cost cutting measures and increased revenue as a priority for the company.
  • Increased Leveraging: Recent increase in debt has also been a point of concern for investors, specially with rising interest rates.

Management notes that they have been maintaining a disciplined approach towards capital allocation. They are focused on growing with a measured approach while maintaining their long-term financial stability.

  • The company is also actively using their stock buyback program, buying back nearly 1.5 million shares in 2023 for over $190 million, a sign that management believes that the company is currently undervalued.

However, this buyback also adds risk to the company as this cash could be used in better ways rather than buying overvalued stocks.