CHDN - Monarch Casino & Resort: Proper Execution Could Bring A Huge Win

Summary

• Margins have improved.
• Funds are available for investments.
• Monarch has the potential to be a solid compounder in the coming years.

Investment Thesis

Monarch Casino & Resort, Inc. (MCRI) is a well-managed company with a promising future. Their stock performance over the past decade has exceeded the S&P 500 by a significant margin. However, in recent years their outperformance has decreased. The management team appears to be taking steps to improve the company's share performance in the coming years. These steps include enhancing margins, returning capital to shareholders through repurchasing shares, and identifying opportunities for organic growth or strategic acquisitions. As I will demonstrate in the following chapters, if executed effectively, Monarch has the potential to be a solid compounder in the coming years.

Introduction

Monarch Casino & Resort, Inc. is a publicly traded company that owns and operates the Atlantis Casino Resort Spa, a hotel-casino located in Reno, Nevada. The company also owns the Monarch Black Hawk casino in Black Hawk, Colorado. They operate in the Gaming, Lodging and Dining industry, providing mainly casino and resort services. The company was founded in 1995 and is based in Reno, Nevada.

As illustrated by the two pictures above, both of Monarch's casinos have significantly boosted their market share in recent years. This is a testament to their commitment to delivering exceptional service, as evidenced by the high ratings and awards they have received. Both of Monarch's casino locations boast strategically chosen locations that possess not only higher population growth rates but also above-average per capita income compared to the national average. This market share growth was achieved through strategic investments in their two resorts, which have yielded favorable results

Analysis

The foundation of our DCF Model is the TTM EPS of $4.49 which serves as a reference point for the growth rate used in the model. This is further supported by a strong historical performance, reflected in the robust past 5-year CAGR in EPS of approximately 25%, and a past 10-year CAGR of around 23%. As a standard practice, we adopt a conservative approach in our analysis. For this reason, we utilized decreasing growth rates after 5 years in our normal case scenario. However, in the best-case scenario, we did not include declining growth rates as we believe there is a realistic possibility that the company may maintain this level of growth. As is customary in our investment analysis, we apply a 10% discount rate to all investments, and the terminal value of the company is adjusted accordingly based on the rates considered possible in each scenario.

As a result of our thorough analysis, we arrived at the conclusion that the shares are currently undervalued. By weighing the different scenarios, we determined that the current share price of $76 is lower than the calculated sum of $107.42.

In the following, we will take a look at various key metrics and examine if they have improved over time. The 5-year averages of the ROE and ROC are as follows:

• ROC: 12,75%
• ROE: 10,39%

Both of these metrics are unfortunately lower than we would have desired. However, they have been negatively affected by the COVID-19 pandemic. Since operations have resumed somewhat to normal, we are seeing an improvement in these metrics. In the long term, we would particularly like to see the ROC in the 20%+ range in order to ensure effective capital allocation. Especially because they possess a good growth opportunity with the 40 acres of land next to the Atlantis. Two very positive points are that since Q3 they have had a net leverage of 0.0x and the properties in which the hotels are located are owned by them, so no rental payments are necessary. The lower graph, which depicts the balance sheets, also nicely shows that the company is in good financial condition. With this flexibility, they could now provide nice returns to the shareholders.

A very interesting point is that in Q3 they mentioned for the first time that they will use their cash flow for share buybacks and returning capital to shareholders. In the past, they always emphasized using this cash flow for debt pay-down and M&A opportunities. This could have a positive impact on the shareholders. In the past, one could gauge the importance of a role based on its position. As a result, there may be reason for shareholders to feel optimistic about the future.

Share Repurchase Plan

In October 2014, they also approved a stock repurchase plan with up to 3,000,000 shares. So far, the only transaction under this plan was on January 19, 2021, where they repurchased 100,000 shares for 6.5 million. Furthermore, a closer examination of the outstanding stocks as of September 30, 2022 reveals an increase of approximately 130,000 shares due to the granting of stock options and restricted stock, compared to the beginning of the year. In my opinion, the effectiveness of these share repurchases should be monitored in the coming quarters to determine if they are not only mitigating dilution, but also generating real value for the shareholders.

Growth Opportunities

Their mobile sports betting apps, according to their statements in the financial reports, have a low operating cost structure and a steady growth. It is currently difficult to identify whether these apps will have a major impact on margins or revenue in the future, as the online sports betting market is still in a very early phase and it will soon become clear which players will dominate the market and in what form. In contrast to Churchill Downs ( CHDN ), they do not own assets such as the Kentucky Derby, which can also generate money through licensing fees. The impact of Colorado Amendment 77 , which became effective in May 2021, will likely have a positive effect on Monarch Casino's revenues in Black Hawk. Since then, the betting limit has been lifted and new games have been allowed. The previous cap was $100 per bet. Now there is an opportunity to actively attract high rollers, who are very lucrative business for casino operators due to their very high stakes. During the final quarter of 2022, Atlantis underwent a significant property improvement, including the addition of a new, high-end retail space. This exciting new addition is poised to drive a positive impact on revenue throughout 2023.

Margins

A positive aspect is that there is a positive trend in the development of gross and especially operating margins over a 5-year period. There has been a very noticeable increase in operating margins from 17.6% in 2017 to 25.1% TTM. This, combined with the rising revenues, has had a very positive impact on earnings. In conclusion, it can be stated that the management has made decisions in recent years that have led to the company now being in a better position than it was five years ago.

Risks

The biggest risk factor lies in the fact that the entire cash flow relies on only 2 resorts. If difficulties arise at one resort, it could have significant impact on the entire company. Furthermore, the competitive landscape is particularly intense in Black Hawk, where there are 21 additional casinos. Furthermore, legislation surrounding online poker, online gambling, and sports betting could further intensify the competitive situation. In addition, it must be said that there is still a difference in experiencing the "real" casino atmosphere, rather than just betting on a mobile phone or computer. The special atmosphere is an important factor. However, there are already providers who are trying to offer this atmosphere online as well. The management has eliminated a significant risk factor this year through their foresight. They paid off debts to avoid being affected by rising interest rates. This could have been a problem as rising interest rates would increase the debt service even if the borrowed amount remains the same. In conclusion, another potential risk factor to consider is the concentration of ownership, as John Farahi, Bob Farahi, and Ben Farahi hold a combined 32% of the outstanding common stock, as per the current 10K filing. This can grant them significant influence over the company, but also ensures that they will be diligent in their decision-making and mindful of the impact on the company.

Conclusion

As previously discussed in my analysis of Churchill Downs , I hold the view that the casino industry presents some intriguing prospects for long-term investments. For those with no ethical concerns, investing in a product that has the potential to create dependency among clients and generate appealing returns may be a viable option.

Monarch, in particular, is renowned for its exceptional management and ability to thrive in a highly competitive market, consistently increasing its market share and margins. As a shareholder, it would be desirable for the company to return more capital to the shareholders. Utilizing the share repurchase program at favorable prices would be a wise strategy. While a dividend may be a possibility in the absence of attractive M&A opportunities, I would prioritize investments in growth over a dividend in the short term. In conclusion, I would state that Monarch is a "hold" for the time being, as I prefer to observe the development of their Return on Capital in the coming quarters and their intentions for utilizing the available capital in the future. Despite that, I hold the view that declining stock prices can offer a compelling opportunity to acquire a long-term compounder. By capitalizing on temporary market weakness, shareholders may strengthen their position.

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