Churchill Downs and the wonders of easy money
Churchill Downs can be the poster boy for the affects of easy money on capital markets. Shareholders have made a killing while the board has kept buying back shares and buying more growth with cheap debt. For a decade now, the stock has followed the broader market, accentuating the up moves while stalling during pullbacks. Generally favorable business conditions in regional markets have also helped as Churchill Downs has beefed up its numbers and keeps breaking its own records. But, the picture is just now getting a bit more wobbly.
Since this is a momentum stock, it needs momentum to continue higher. Otherwise it falls. The last stall from late 2015 to early 2017 lasted a year and a half before the uptrend was reestablished. We are now exactly one year into the most recent consolidation. The next few months then should be telling. If the U.S. economy is going to boom for another year, then Churchill Downs could see one last leg higher. If not, we could eventually fall back down to the $50 area, the jumping off point of the previous rally. This is not a stock that is just going to relax and trend slowly higher. It’s either going much higher, or much lower.
If we look into its growth strategy, we can see pretty clearly what’s happened here, and how easy money affects stock prices. Since 2014, Churchill Downs has bought back nearly $1 billion in stock, about a quarter of its market cap. $938.8 million to be exact (page 36 here). Since 2014, its market cap has grown by $1.18 billion. 80% of that move, then, was just money that it plowed back into its own stock year after year as it became more and more expensive. Where did this $938.8 million come from? Well, $711 million of it came from an increase in its debt holdings since 2014. It basically borrowed money to buy its own stock back. This doesn’t even include the additional $243 million that the board has set aside for further repurchases down the road. If we add that in, total stock buybacks executed and authorized equals $1.18 billion since 2014, the exact increase in its market cap since that year. If traders are front-running these stock repurchases, then that fuel is exhausted, unless still more is soon authorized.
You can try to point to growth statistics to justify Churchill’s meteoric rise, and growth has at least something to do with it. But much of its growth though has been through acquisitions. Without further acquisitions then, growth is going to slow down. The stock’s current price is the result of a combination of its very generous buybacks, plus top line acquisition-fueled growth. If both of those are not sustained at current rates, the stock is going to have to fall. At this point, with debt becoming substantial and nearing $1.5 billion, it’s going to have to slow down and take a step back and consolidate its new holdings. At the very least this should put capital growth on hold, with some scary falls during broader market stress.
Growth though, is not broad-based. Net revenue in its Churchill Downs segment was up $19M last quarter on the opening of Derby City Gaming last year, pushing EBITDA into positive, but just barely at $1.4 million. Online wagering was static, with EBITDA down 5.6% from last year. Online gaming brand TwinSpires revenue was down slightly while revenue per active player decreased by 3.3%. This was despite record online handle of $30.2 million at the Kentucky Derby, up 23% over last year.
Gaming revenue was up nicely by $57.6 million, but this was mainly due to acquisitions as well. $29.7 million from the acquisition of Presque Isle in January, $18.4 million from the acquisition of 37.5% of Ocean Downs last August, and another $2.3 million from other minor acquisitions. That accounts for 87% of growth in that segment.
Like most companies taking on more debt than they’re used to, Churchill Downs is using much of it to pay back existing debt while interest rates remain low. Lucky for them, now that 2017 notes are paid down with 2027 and 2028 notes, there are no significant debt repayments until after 2024. But that doesn’t solve much. Just taking a step back and digesting is going to make shareholders antsy for more growth. In order to continue that rate since 2014, the current pace of buybacks and acquisitions will have to continue, and that will require Churchill Downs to go even deeper into debt, unless it can pull off some spectacular organic growth over the next year or two, which looks very unlikely.
Back in 2015, Churchill Downs stalled for a year and a half, moving in tandem with both the Macau complex and the rest of the S&P 500. Zoomed out on a long term chart, it looks like it was easy to hold through, but that’s misleading. It only looks like a brief stall in the context of its 100% or so rally since the beginning of 2017. The 2015-2017 consolidation pattern is now playing itself out again, but this time it’s even more volatile. For those who play spreads, it’ll provide plenty of opportunity for short term trading, but it’s like riding the mechanical bull.
None of this analysis takes into account a possible recession, which is what would trigger the stock to collapse back to the $50 support zone. On the first clear sign of a U.S. recession then, this will be a prime stock to short. We may never get that before the trip down begins, but traders can try to use Churchill Downs in order to triangulate a possible turn in the U.S. market.
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