An Overvalued Monarch Casino & Resort Is A Niche Casino Operator With No Growth Ahead

| About: Monarch Casino (MCRI)
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With the proliferation of gaming across the U.S. and the rise of Macau as the number one gaming destination in the world, there's no denying the potential in the casino space. But one area that is sure to not be the next "hot" gaming market is Reno, Nevada. Heck, it's not even in the right part of Nevada. But that hasn't stopped investors from falling all over themselves for Monarch Casino & Resort (NASDAQ:MCRI). Shares have had quite a ride this year, rising over 81% YTD. However, shares now appear to be in overbought and overvalued territory.

An obscure casino market operator

Monarch owns the Atlantis Casino Resort & Spa in Reno, Nevada and the Monarch Black Hawk Casino in Black Hawk, Colorado. Both properties cater principally to the local market. The Atlantis has a more seasonal business with higher revenues in the summer months compared to the winter months.

The Atlantis is located three miles south of downtown Reno and is the only hotel facility to be physically connected to the Reno-Sparks Convention Center through a skywalk. The hotel facility includes three contiguous towers with a total of 824 rooms and suites. The casino features approximately 1,450 slot and video poker machines and 38 table games, a 24-hour live keno lounge and a poker room. There are eight restaurants, two gourmet coffee bars and one snack bar. Last year, the Atlantis boasted an 87.2% occupancy rate and an average daily room rate of $71.13.

Just last year, Monarch snatched up the Riviera Black Hawk Casino and renamed it the Monarch Black Hawk Casino. It is the first casino encountered by visitors as they arrive from Denver on Highway 119. The property features approximately 32,000 square feet of casino space, 750 slot machines, 10 table games, a 250 seat buffet-style restaurant, a snack bar and a parking structure with approximately 500 spaces. Monarch does own a 1.5 acre land parcel contiguous to the Monarch Black Hawk Casino which is zoned for gaming and can be utilized for future expansion. The problem with this property is that it does not have a hotel.

Intense competition in both markets

The biggest issue with this small-time casino operator is that Monarch does not have a monopoly in either market where it operates. In Reno, there are 13 other casinos that each generated more than $12 million in annual gaming revenues. This is certainly a lot to compete with in a market that did only $645 million last year in total gaming revenues. In this market, the Atlantis is competing with other well-known properties Circus Circus, Peppermill, Harrah's, Silver Legacy, Eldorado and the Sands Regency.

The Black Hawk market is even more intense. The Black Hawk market consists of 26 casinos, which generated $630 million in gaming revenues last year. The market could get even more intense as there are a number of proposals in the Denver area to expand gaming from Native American interests, racetracks and video lottery terminals. For Monarch, the lack of a hotel certainly hurts in competing for customers. In this market, the primary competitors are Ameristar, Isle of Capri, Lady Luck, The Lodge, Mardi Gras, The Gilpin, Golden Gates and Black Hawk Station. Matter of fact, Ameristar has a 33-story hotel and casino that Monarch competes with.

Ameristar's 33-story hotel and casino

Casino review reveal even more issues

The reviews on Yelp are certainly not anything to write home about. While older reviews have been more positive, the most recent reviews have taken a negative tone.

"11/28/2013: Had the misfortune of staying here on my way out of Tahoe. Like a nightmare reminiscent of Ocean's 13, woke up with a rash, told the front desk- not even an apology, just a reminder that I'd be charged a resort tax. Great way to lose repeat business. Everyone recommended the Pepper Mill over this toxic dump, even the employees at Atlantis. No nightclub, horrible service and found long brown hairs in my shower to boot, courtesy of housekeeping."

"11/21/2013:

FOOD POISONING

Almost died

Never drink

No medications

Bad clams

Many other food poisoning complaints

Will spread the word before they poison more people"

"12/16/2013: this was horrible. we had free rooms from an offer. never stayed here and never will again. we wanted to stay at the casino to play and gamble since we got free rooms. we went to the $1 slots first and could not get a drink to save our lives.

We have stayed locally at the peppermill (frequently) and in tahoe at multiple casinos and never experienced such a lack of service. do not even try to compare this place to Vegas. if you do, you haven't gone to vegas."

The reviews by employees on Glassdoor are not much better.

For the Monarch Black Hawk Casino, it's not any better on Yelp.

"8/21/2013: don't eat here. Me and my husband and our friend, all ate here tonight. First off, you only get one lobster and it is relatively tiny. We ate our lobster and then went to eat the crab, the crab was so dry and it had a weird burnt taste to it. We didn't even finish what was on our plate because it was soo bad. The prime rib, along with almost everything, was very dry. Unless you just want to eat a small lobster and salad, don't eat here. Also the waitress completely ignored our empty cups, we left thirsty."

"2/5/2013

Cons:

1. There's no place to sit. - There's no place to lounge and enjoy a beer aside from the very small bar. The problem with this is that people end up sitting at machines just to rest their feet, making it tough to find a machine you want to play.

2. Not enough table games. - One roulette table with 8 people packed around it, one craps table with 15 people crowded around it, 3 blackjack tables completely full, and 1 or 2 poker tables - that's it! If you want to play table games (I did), you will probably need to go elsewhere if you don't want to wait in line for a half hour + to do it.

3. Too many machines packed in a small place. - If you're at a machine, your neighbor is basically in your lap. And given the type of clientele that was in there that night, that's NOT a good thing. The space between the chairs (back to back) is only barely big enough for you to squeeze by. There's no space for you to stand behind someone and watch them play without blocking the entire walkway."

And meanwhile, over at Glassdoor...

Despite the competitive market and poor reviews by visitors and employees, two key headwinds remain

The fact of the matter for regional casino operators like Monarch, is that there are two main headwinds that all of them are facing, and neither of which is going away anytime soon. The first is the current recessionary macroeconomic factors that exist. While the unemployment rate has been slowly improving, levels are still not where they were before the financial crisis. Consumer spending is not as strong as it once was and we feel that consumers have certainly gotten more cautious about spending their hard-earned dollars.

The second factor facing Monarch is the current promotional environment among the regional casino players. The competition is intense and competitors are using various promotions to get customers into their doors. For Monarch in Colorado, not having a hotel in Black Hawk is a significant disadvantage in the current promotional environment. For Monarch in Reno, Station Casinos has several parcels in the Reno area with plans to build a new hotel and casino. Station Casinos is known for catering to locals and would be a serious competitor to the Atlantis.

All of which leads to its current overvaluation

Our thesis rests on the fact that we see Monarch's current valuation as having gotten ahead of itself. While we are not critical of the way management has run the company for stockholders with a LTM leverage ratio of only 1.2x, we feel that the current valuation isn't warranted. If we look at other casino operators, we see how Monarch compares.

Monarch

ISLE

PENN

BYD

PNK

Market Cap

$325M

$350M

$1.12B

$1.20B

$1.53B

P/E

19.08

N/A

12.87

N/A

N/A

Forward P/E

N/A

38.22

26.38

53.10

9.20

P/S

1.71

0.36

0.37

0.44

1.10

P/B

2.06

2.41

0.47

2.45

7.93

EV/Sales

1.89

1.42

1.08

1.89

4.16

EV/EBITDA

7.91

8.23

4.45

9.95

20.87

52-week change

81.21%

56.96%

30.68%

67.92%

63.36%

Source: Yahoo! Finance

Analysts have a $20.58 mean price target, which is just 4% above its current price. As well, analysts expect the company to only grow EPS at a 7.1% CAGR over the next five years. Coupling its 19x and EPS expected CAGR and its PEG ratio is a fairly high 2.7.

Given the poor market prospects, both its local markets and the broader economic market, we believe a re-rating of Monarch's multiples will take place over the next year. Margins are still well below pre-financial crisis levels and it trades at a sizable premium to its five year average multiples. This includes its five year average price to sales multiple of 1.2x. Even at 1.2x sales, that's a premium multiple to its current peers. Even taking into account Monarch's balance sheet strength, Monarch is still trading at a premium to major peers on an EV/sales basis.

We believe that Monarch should trade closer to peer Isle, which owns 15 properties, versus Monarch's two. However, Isle has an expected EPS CAGR that's very close to Monarch's. In any case, a 1.4x EV/sales multiple on 2014E sales of $194 million, suggests a price target of $14, 30% downside.

Even if we assume its EV/sales multiple remains stable, using 2014E sales, the upside for the stock is only to $19.97, which is 1% upside. The risk/reward appears to be heavily skewed toward the risk side.

Bottom line

While we praise management for keeping the leverage ratio low - as a matter of fact, much lower than its peers - we feel that the two markets that Monarch operate in simply don't warrant shares trading at 19x earnings or 1.7x sales. The company will have to leverage its balance sheet in order to build a new hotel to better compete in Black Hawk and we feel that the Black Hawk market is too competitive to warrant such an investment. If Monarch were operating in markets with higher growth prospects, we would be much more excited about the company. However, that is not the case and we see this rally as having run its course.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.