Our Valuation of the Gaming Industry
Overall, we think the gaming industry is fairly valued at this time. The industry's market cap is trading between 80% and 120% of our estimate of its fair value based on our DCF process. However, we do think an interesting pairs trade exists between Churchill Downs (CHDN) and Penn National (PENN), two constituents we cover.
We use a firm-specific ValueRisk™ measure to determine whether a firm is undervalued or overvalued based on our DCF process, but we consider an industry to be undervalued if it is trading below 80% of our estimate of its fair value and overvalued if it is trading at over 120% of our estimate of its fair value. We think these fair value ranges are appropriate given the diversification benefits of holding a basket of stocks.
Although we point to Penn National as an interesting long opportunity within the space, we don't find the industry as a whole attractive based solely on valuation. On the other hand, we view Churchill Downs as significantly overvalued and a good short candidate at these levels. In fact, we are currently evaluating opening up a put position in Churchill Downs in our Best Ideas Newsletter.
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Source: Valuentum Securities, Inc.
Boyd Gaming (BYD)
Fair Value: $5 per share
We think Boyd Gaming's shares are worth between $3 and $8 each. The wide margin of safety around our fair value estimate is driven by the firm's VERY HIGH ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $5 per share represents a price-to-earnings (P/E) ratio of about 42.2 times last year's earnings and an implied EV/EBITDA multiple of about 8.9 times last year's EBITDA.
We forecast a compound annual revenue growth rate of 2.6% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 2.3%. We assume an average operating margin of 8.2% during the next five years, which is below Boyd Gaming's trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will fall steadily at an annual pace of 2% for the next 15 years but grow 3% in perpetuity. For Boyd Gaming, we employ a 7.9% weighted average cost of capital to discount future free cash flows.
Churchill Downs
Fair Value: $28 per share
Our discounted cash flow model indicates that Churchill Downs' shares are worth between $20 and $36 each. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $28 per share represents a price-to-earnings (P/E) ratio of about 22.4 times last year's earnings and an implied EV/EBITDA multiple of about 8.1 times last year's EBITDA.
We forecast a compound annual revenue growth rate of 7.2% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 12.5%. We project a 5-year projected average operating margin of 10.5%, which is above Churchill Downs' trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of about 4% for the next 15 years and 3% in perpetuity. For Churchill Downs, our model uses a 9.4% weighted average cost of capital to discount future free cash flows.
Dover Downs (DDE)
Fair Value: $4 per share
We think Dover Downs' shares are worth between $2 and $6 each. The relatively large margin of safety around our fair value estimate is driven by the firm's VERY HIGH ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $4 per share represents a price-to-earnings (P/E) ratio of about 18.7 times last year's earnings and an implied EV/EBITDA multiple of about 7 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 3.6% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of -0.6%. Our model reflects a 5-year projected average operating margin of 6.9%, which is below Dover Downs' trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 5.3% for the next 15 years and 3% in perpetuity. We use a 7.6% weighted average cost of capital to discount future free cash flows.
Las Vegas Sands (LVS)
Fair Value: $39 per share
Our discounted cash flow model indicates that Las Vegas Sands' shares are worth between $26 and $52 each. The margin of safety around our fair value estimate is driven by the firm's HIGH ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $39 per share represents a price-to-earnings (P/E) ratio of about 51.5 times last year's earnings and an implied EV/EBITDA multiple of about 18.9 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 18.3% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 32.4%. Our model reflects a 5-year projected average operating margin of 23.8%, which is above Las Vegas Sands' trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 7.4% for the next 15 years and 3% in perpetuity. For Las Vegas Sands, our model uses a 10.6% weighted average cost of capital to discount future free cash flows.
MGM Resorts (MGM)
Fair Value: $11 per share
Our discounted cash flow model indicates that MGM Resorts' shares are worth between $7 and $15 each. The margin of safety around our fair value estimate is driven by the firm's HIGH ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. Our fair value estimate is $11 per share. We project a compound annual revenue growth rate of 15.6% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of -7.8%. Our model reflects a 5-year projected average operating margin of 9.8%, which is above MGM Resorts' trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 8.7% for the next 15 years and 3% in perpetuity. We employ an 8.4% weighted average cost of capital to discount future free cash flows.
Penn National
Fair Value: $50 per share
We think Penn National's shares are worth between $35 and $65 each. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $50 per share represents an implied EV/EBITDA multiple of about 9.9 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 7.4% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 0.3%. We project an average operating margin of 14.1% during the next five years, which is below Penn National's trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 1.7% for the next 15 years and 3% in perpetuity. For Penn National, we use a 8.6% weighted average cost of capital to discount future free cash flows.
Pinnacle Entertainment (PNK)
Fair Value: $10 per share
Our discounted cash flow model indicates that Pinnacle Entertainment's shares are worth between $7 and $14 each. The margin of safety around our fair value estimate is driven by the firm's HIGH ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $10 per share represents an implied EV/EBITDA multiple of about 7.8 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 5.6% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 5.9%. Our model reflects a 5-year projected average operating margin of 11%, which is above Pinnacle Entertainment's trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 5.4% for the next 15 years and 3% in perpetuity. For Pinnacle Entertainment, our model uses a 8.9% weighted average cost of capital to discount future free cash flows.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
