Eldorado Resorts Could Have More Upside
ERI has had a tremendous run, having better than tripled in the last 18 months.
Valuation is getting a bit high relative to peers, but ERI still may be in the earlier stages of the margin enhancements that have improved valuations across the space.
I’ve long been bearish (and wrong), and may be turning toward the stock at the top. But I see enough in Reno and Ohio to drive further growth.
Up front, to be clear: I’ve been wrong on Eldorado Resorts (NASDAQ:ERI). Dead wrong, still wrong, and then wrong again. I haven’t shorted the stock (or recommended shorting it), but I pushed (and bought) peer Isle of Capri (NASDAQ:ISLE), for example, only to wind up having to execute a well-timed average down simply to escape that trade with a modest profit. Meanwhile, ERI has continued to climb:
Source: finviz.com
In my defense, some of my concerns have come to fruition: Full-year 2015 net revenue actually
declined year over year, for instance, driven by a huge leg down at Mountaineer following the mid-summer institution of a smoking ban. But I underestimated the Reno market, underestimated Ohio, and underestimated Eldorado management’s plans to, and ability to, take substantial costs out of the business.
Above $14, I admit Eldorado’s valuation looks a bit stretched, and I may be turning (somewhat) bullish at exactly the wrong moment. Again, I’ve missed the story so far, and I’m a bit more skeptical about the regional space than I’ve been for some time. Peers like Boyd Gaming (NYSE:BYD) and Isle of Capri seem to have neared their respective limits in terms of margin expansion, and growth in several markets appears to have slowed as Q4 2014/Q1 2015 comparables (both boosted by $2 gas) are lapped.
The bull case for ERI, though, is that Eldorado still is in the early innings of the same transformation that boosted profits and valuations at those peers – yet trades in line with BYD and not terribly ahead of Penn National Gaming (NASDAQ
ENN) or ISLE. I do think a growth slowdown is on the horizon, and looking to 2017, the bull case will hinge on further cost improvements and whether the Reno market truly will see the long-term renaissance some are predicting. Right now, I think there’s enough evidence to support that case.
Looking Forward
The bull case for ERI has been well covered on this site, with contributors Darren McCammon and Oliver Rheinfurth, among others, beating the market to the story. Then-private Eldorado, with a largely Western focus (Nevada and Louisiana) merged with Eastern-heavy MTR Gaming, then used the larger earnings base to refinance its debt. Eldorado then bought out MGM Resorts International’s (NYSE:MGM) 50% share of a joint venture in the Silver Legacy and Circus Circus in downtown Reno, creating a three-casino complex in that growing market. Synergies from the integration of those properties (as well as the Eldorado/MTR tie-up), interest savings, and growth at Scioto Downs in Ohio all had the potential to drive profits.
There were some concerns, as I pointed out at the time, notably the impact of a smoking ban at Mountaineer, long a key property, as well as the entrance of a new Margaritaville casino in Shreveport and the possibility of impact from the oil and gas bust in northern Louisiana and Texas. Those concerns did come to pass: Mountaineer revenue declined 19% in Q3, over 17% in Q4, and 16% in Q1, and Shreveport revenue grew just 1.8% in 2015 before declining in Q1. But strength elsewhere – notably Reno and Ohio – was more than enough to offset Mountaineer’s decline, and cost controls allowed for tremendous EBITDA gains at Shreveport (20.2% in 2015) and an improvement at long-struggling Presque Isle in Pennsylvania (which grew profits 4.6% for the year despite posting declines through the first nine months).
The improvements in margins were the key issue I missed from an operational standpoint. Those improvements led not only to higher profits but a higher multiple, as ERI’s EBITDA multiple has expanded by about 1.7 turns in the past year-plus. Given ~5x leverage at the moment, that expansion has a significant impact on the equity value: In the range of $6 per share. Looking at property by property, I do think much of the low-hanging fruit has been captured, and that might preclude ERI continuing its torrid appreciation:
Ohio. The Ohio market as a whole disappointed at first, but over the past few quarters, it’s been one of the best regional markets in the country. One big surprise from my perspective has been the fact that Eldorado’s slot-only Scioto Downs continues to take share from Penn’s Hollywood Columbus (which offers table games in addition to slots). Scioto’s competitive edge has continued into Q2, with Ohio Lottery figures showing Scioto Downs posting 5.7% and 3.7% increases in net win in April and May, respectively. Penn’s Hollywood Columbus, meanwhile, saw net revenue grow just 0.3% in April and decline 3.4% in May.
That’s good news, to be sure, but I’m not sure how much really is left in terms of margin expansion at the property. Ohio has a far higher gaming tax rate than other properties (33% on a gross basis), yet property margins of 34.8% (on a trailing twelve-month basis) already dwarf those elsewhere in the portfolio. A new Brew Brothers restaurant has been very well received, with multiple Yelp reviews citing long wait times.
The impact of that opening will be lapped in October. A new hotel will open later this year, but I remain somewhat skeptical that it will drive much more visitation in what’s obviously very much a ‘locals’ market. (There simply isn’t much in the way of population in the entire region that isn’t within an hour’s drive of a casino. Scioto Downs may pull some incremental business traffic but I can’t see much demand for weekend visits, for instance.)
It still seems wise to model double-digit EBITDA growth for Scioto in 2016, given Q1 results (11.7% growth on a 5.5% increase in revenue). Looking at 2017 and beyond, however, margins seem near a ceiling, and the Ohio market as a whole seems likely to mature. To be fair, competition won’t be a factor, as in-state licenses are capped, surrounding states are mature, and Columbus is located almost in the center of Ohio.
There’s an expansion of the smoking patio in Columbus on the way, and smaller percentage growth from a larger base (the property is Eldorado’s most profitable on an absolute basis as well) can help overall results. But I still think earnings models have to incorporate lower (i.e., high-single digits even in a positive scenario) growth from Scioto going forward.
West Virginia. At this point, most of the impact from the smoking ban and Ohio’s 2012 in-state openings has been incorporated into property-level results, one benefit for Mountaineer. And there still is some right-sizing coming on the cost side, plus the expansion of a smoking patio, while the smoking ban itself will be anniversaried in July. Q1 EBITDA was down 31% (after a 30% full-year decline in 2015), and the property seems headed for the $16-17 million level in 2016, down another ~20% from 2015.
But CFO Tom Reeg said on the Q1 conference call that Eldorado believes it can get profits back to the ~$21 million level seen in 2015 by Q3/Q4 of CY2017. The physical footprint is getting smaller, and there’s likely room to better match costs to the new, lower revenue base. Post-2017, the competitive environment will be pretty much rationalized, with Ohio and Pennsylvania stable and in-state business traditionally a tiny part of Mountaineer’s business (under 3% in 2013, for instance, per MTR’s 10-K). VLT expansion in Pennsylvania could pose more pressure, and it’s difficult to see from where Mountaineer can drive growth once it moderates the impact of the smoking ban. Growth expectations longer term seem likely to be muted – likely lower than Ohio’s.
Shreveport. The big risk to ERI’s Q2 report, likely to be released in August, appears to be the Eldorado Shreveport. April and May figures from theLouisiana Gambling Control Board portend a dismal quarter, at least in terms of gaming revenue. April win was down 2.4% year over year (with the market down 3.4%). May revenues fell a staggering 15.5%, against a 13.5% decline market-wide.
Reeg cited cost control for a 19% increase in Q1 EBITDA off a modest decline in revenue (flooding impacted the property as well) and the same factors certainly drove 2015 growth. ‘Flowthrough’ (the percentage of property-level profit increases relative to revenue gains) was 205% in 2015, as costs have fallen on even an absolute basis. The Eldorado has apparently not seen much impact from the oil and bust that has hit part of Texas and Louisiana, but that may have changed in Q2, as the lagging impact of unemployment finally hurts spend. (That type of delayed reaction has been the case at Texas-heavy retailer Stage Stores (NYSE:SSI), for instance.)
There was a ‘calendar shift’ in May (four weekends against five the year before) which likely had a significant impact on the weekend-heavy Shreveport market – but that’s not enough to explain away such a steep decline, and as noted, April was down as well. Reeg had cited ERI’s pride in getting Eldorado Shreveport profits back near levels seen before the 2013 opening of the Margaritaville in neighboring Bossier City, but that added capacity isn’t helpful if there is indeed some macro pressure on visitation. Given that there’s likely less fat to cut as well, after cost reductions over the past few quarters, Shreveport could put some pressure on overall growth for the balance of the year.
Presque Isle Downs. One of my concerns about ERI post-merger was how the legacy Eldorado management – used to operating destination casinos – would fare in the more locals-oriented Eastern markets served by MTR. The continued share gains in Columbus – against Penn, no less, a company that I’ve long considered ‘best in breed’ in the regional space – certainly dispelled the concerns.
The same goes for some of the moves at Presque Isle, which was struggling for some time before ERI reoriented marketing to the locals base (the property generally had targeted customers from eastern Ohio and western New York State). A new Brew Brothers opened there in May, and the property has swung to 4%+ top line increases in both Q4 and Q1 after seeing revenue and profit declines through the first three quarters of 2015.
Again, post-2016, however, it’s tough to see much in the way of growth. Competition is coming in New York State in 2017, and a tribal casino in Buffalo is planning a major expansion. The property is basically surrounded by competition at this point, and Erie is both a small market and one with a still-wobbly local economy. This is the smallest property in the portfolio from a profit standpoint, so ERI can manage a decline. But once Presque Isle starts to lap tougher comparisons in Q4, and faces competition in 2H 2017/2018, there’s a good chance the focus will move toward keeping profits flat, not looking for growth.
Reno. There’s still room for double-digit EBITDA growth this year, in my opinion. McCammon targeted a full-year figure of $185 million in March (up about 15.5%), though my estimates are a bit more muted. Particularly assuming Shreveport sees a profit decline in Q2, 10-12% growth to $176-$178 million looks about right from my models. (Readers might want to choose McCammon’s figures over mine at this point.)
From there, I think growth gets a bit tougher: Scioto can drive 4-5% consolidated increases on its own (off a ~$60 million base this year), Mountaineer can add 2-3 points in 2H16/2017 before leveling off, and I’d be outright concerned about Shreveport and Presque Isle. If Eldorado can continue to drive cost reductions – and management appears confident that there’s more room – than there may be potential for profit growth post-2016 toward the $200 million level.
That’s what ISLE and BYD, most notably, were able to accomplish, with Boyd repeatedly beating its own margin targets last year and driving shares up nicely. Those efforts already are starting to peter out, however (particularly for ISLE), so in Shreveport and the East it’s still a question as to how much room Eldorado really has to further boost margins.
That’s not the case in Reno, however. The consolidation of the three casinos still is in progress, and there’s likely room for improvement both on the cost side and on the revenue side. As McCammon has pointed out, there are 24 restaurants in the three casinos, some of whom appear redundant. There certainly are other possible savings, ranging from labor costs to marketing expense – and potential economies of scale behind that marketing and driving repeat visitation. Meanwhile, Reno as a whole appears to be in an economic uptrend after a slow recovery from the financial crisis, with Tesla (NASDAQ:TSLA) building its Gigafactory to the east, unemployment at multi-year lows, and (per ERI management on the Q1 call) eight new direct flights added to the Reno-Tahoe airport.
The ‘Tri-Properties’, as Eldorado now calls the three casinos, will benefit this year from a national bowling tournament (held every other year), which will impact 2017 comparisons somewhat. But beyond the numbers, Reno to me looks like the ‘hinge’ on the bull/bear case. The growth potential on the rest of the portfolio really doesn’t look all that different from Boyd or Isle of Capri (Scioto is better than any Isle property, however), so choosing ERI when it’s valued above peers requires choosing Reno over Boyd’s bet in North Las Vegas, Isle’s relative valuation, or Penn’s diversified portfolio and opportunities on the Strip and in Massachusetts.
As the Reno properties continue to show torrid growth – nearly 7% revenue growth and a 49% increase in Adjusted EBITDA in Q1, for instance – that choice makes some sense. There’s still a lot of opportunity simply in the integration of the resorts. Eldorado’s RevPAR jumped a stunning 21% in Q1, thanks to increased resort fees. That’s money that falls almost purely to the bottom line, and it certainly seems there’s more room for that growth over the rest of the year. Meanwhile, the overall market growth certainly supports the story for Reno as a whole: April results for the six largest Reno casinos were
up 20% year-over-year, and 10% on a trailing three-month basis. (May results haven’t been released.)
Again, the bowlers do provide a bit of a one-time boost relatively to 2015 and 2017. But Q1 also offered some harsh weather and a shift of Easter (a slow weekend) into the quarter, both headwinds that ERI shrugged off easily. If the consolidated Reno properties can go from a trailing ~$53 million in Adjusted EBITDA to $80-90 million over the next few years, that alone can drive ~20% overall profit growth from current levels. And that’s a growth opportunity that peers don’t really have at the moment.
Valuation
Again, I’m a bit wary of being wrong at both the bottom and the top, and I’m still kicking myself for not grasping the story here from the jump. But if management can continue to improve margins the way that peers have over the past few quarters, and if the Reno ‘story’ holds, there’s room for profit improvement through 2017 at least. Given leverage, that can drive significant upside for the equity.
I’d look for something close to $178 million in 2016 Adjusted EBITDA, which assumes a 20% decline at Mountaineer ($17 million), 5% growth in Shreveport ($30 million, assuming a rough Q2 and potential back-half pressure), 12% growth in Scioto ($60 million), 35% growth in Reno ($65 million), and 20% growth at Presque Isle ($22 million), less $16 million in corporate costs. (The figure also matches up somewhat well with guidance for year-end gross leverage to be below 4.5x; that would imply $800 million in year-end debt, down another ~$30 million from Q1 levels.)
Backing out estimated share-based comp (for the entire group), that puts ERI’s EV/EBITDA multiple at about 8.5x, below Boyd (8.8x), and a little less than a turn ahead of PENN and ISLE (7.7x and 7.6x, respectively). Free cash flow, assuming $50 million in capex, $45 million in interest expense, and $1.5 million in state taxes (that guidance from the Q4 call; ERI won’t pay federal taxes until next year, and “marginally” then) would be about $81 million, and $96 million excluding project capex. That’s a ~7x multiple to the latter figure, again marginally above peers.
Still, if the Reno opportunity is real, that alone could argue for a premium: 9x EBITDA or 8x FCF both get shares over $16, for about 15% upside. If there’s room for several more quarters of cost-cutting, those multiples to 2017 EBITDA of $195 million (high single-digit growth) can support a billion-dollar market cap, or a share price around $21. At this point, I don’t see that type of opportunity available at peers (one reason why I closed my position in ISLE earlier this month).
Eldorado also is talking about additional M&A as it delevers, and that could provide another opportunity to boost profits. I’ve argued that micro-cap Full House Resorts (NASDAQ:FLL) could be an interesting target (though I’m biased toward FLL, which I own, and the properties may be too small for Eldorado). The most interesting combination in the entire space would be an ERI/ISLE tie-up, as the portfolios complement nicely and could be opportunistically enlarged as Caesars Entertainment’s (NASDAQ:CZR) regional portfolio (perhaps) becomes available.
I do worry about the macro situation here, and as noted, I’ve become a bit more skeptical about the regional space overall, which even beyond ERI has had a huge run over the past 18 months or so. ERI’s multiple has expanded – but so have most of the multiples in the space to levels well above what they were just a few years ago.
There’s some logic behind that – notably, balance sheets have improved tremendously, and refinancings have pulled interest down sharply – but I also wonder if the group isn’t destined for a correction in the not-too-distant future.
Shreveport and Mountaineer combined could weigh on the Q2 report (even if Reno looks set for a banner quarter) and I’m not sure I personally am ready to jump in quite yet. But, at the moment and at the least, I find ERI the most intriguing stock in the regional space – and I sure didn’t think I’d write that sentence just a few short months ago.
