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Lots of investors begin to get skittish about a stock that gets near its 52-week trading range, especially if there is no dramatic news foretelling an actionable breakthrough. So, what happens is that an even widely recognized solid performer such as Monarch Casino & Resort Inc. (NASDAQ:MCRI) hits a wall.
- Average volume : 44,543
- Volume at yesterday's close: 141,523
- Yesterday's close: $24.89
Its 52-week trading range is $17.29 -$26.13, and its consensus target is $27. We think that's low. Its price as of when this article was written is $26.
Its latest earnings results reinforced a "steady as she goes" growth performance. Below are a few highlights.
Through Q3 2016:
- Casino: $125m, up 7.1% yoy
- Food and beverage: $44m
- Hotel: $18m
- Other: $8.3m
- Promos: (11.9m)
- Net revenue: $161m
- Adjusted EBITDA: $37.6M up 9.3% yoy
- Net income: $15.5m up 16.5% yoy
- Diluted EPS: $0.90 up 14.4%
Q3 was the eighth consecutive quarter of doubt-digit income growth. Earnings are projected to grow at a 14% rate through 2019.
EV/EBITDA: Its range in this metric has moved across a spectrum from a minimum of 4.3 to the maximum of 13.9. And now sits at 8.71, valuing the company at $435m.
Long-term debt as of Q3 2016: It has $29.9 million against total assets of $248.9 million, producing a long-term debt to asset ratio of 0.11%. For a sector that by its nature is always expected to be heavily levered, Monarch is a standout.
The company is in the middle of a capex program at both of its properties. The program targets a freshening of the Atlantis property in Reno and a major expansion to 1,5000 garage spaces, plus the addition of a 500-room tower to its Monarch Black Hawk Colorado property, which will transform that operation into a full-scale casino resort. Of the total planned, $151 million has already been spent, leaving around $380 million left to spend through 2018. To this end, last July Monarch increased its credit availability from $100 to $250 million. That line, plus free cash flow from operations, will easily finance its entire expansion.
For Black Hawk, the company got its temporary certificate of occupancy for the expanded garage this month and expects to complete the 500-room tower by early 2019. Assuming an average citywide occupancy percentage, the tower that's planned will open an inventory of 18,250 room nights per year. We're using a conservative average annual occupancy number of 80% for the tower, or 14,600 room nights. Taking the average rate for existing Black Hawk rooms at $75 a night yields a potential $11 million in annual high-margin revenue to the property. On a total revpar basis, that number could triple. The property sits only 40 miles from the burgeoning metro Denver market, the first off the ramp from the key feeder highway leading to Black Hawk. By any measure, the ROI on this capex project is solid gold.
Gaming to non-gaming revenue an eye-opener vis-a-vis Las Vegas strip operators
Not widely noted even in the most bullish analysis we've seen is that Monarch's gaming/non-gaming revenue ratio stands at 78% gaming to 22% non-gaming. Compare that to major Las Vegas strip operators where the distribution is approximately the reverse, with around 35% in gaming and 65% in non-gaming. Part of this relates to the differences in the markets. Monarch's two properties are in Reno and Black Hawk, Colo., neither of which are tourist destinations per se. That means their customer base may well like its non-gaming amenity offerings, but they essentially come to gamble.
Revenue from gaming margins are always higher than any other service line in a casino operation. Mass food and beverage revenue traditionally carries low to break-even margins, depending on the dining outlet. Beverage margins are huge but food is always tight. Rooms provide great margins even at promotional prices. They are calculated against a cost base of anywhere from $28 to $35 a day to maintain against an average daily rate that can run as low as $75 and as high as $150 depending on the calendar, event, or day of the week. But unless you command a massive inventory of rooms -- as MGM (NYSE:MGM) does, for example -- your net room profit total pales vs. gaming.
Monarch's promotional allowances are also clear evidence of superior comp cost management -- especially in a regional casino market catering to savvy repeat customers sensitive to slot hold percentages. This tells us that Monarch manages its comp costs better than a lot of its peers, and much more of its high margin gaming revenue falls to the bottom line.
Operating Expenses as of Q3:
- 2016: $133m
- 2015: $126m
So, roughly, an 8.5% increase in revenue was produced out of a 5.5% to 6% increase in operating costs. This is indicative of a management in full control of costs, margins and a deft marketing programming.
Ownership profile as of November 2016
Unlike many of its large-cap peers, Monarch's institutional ownership percentage only stands at 56.21%. But the identity of its five biggest holders is instructive:
- JP Morgan Chase: 1.173 million shares
- Wellington Management: 848,000 shares
- Davenport & Co.: 798,000 shares
- Blackrock Fund: 767,000 shares
- Lafitte Capital Management: 686,000 shares
The grand total of all institutions is 9.7 million out of approximately 17 million shares outstanding.
Members of the founding Farahi family, who are active in management, have sold shares into the upward move this year, including COO David Farahi, who sold 5,000 in the last quarter. Yet, all in, insider sales have been minimal against an upside inflow. In Q3, institutions bought 11.4 million shares and sold 4.4 million shares to produce a plus net inflow of 6.3 million shares.
What do these guys know that we might not? And what do we know that they might not, since most of them tend to operate on standard algorithm-triggered metrics?
Given the sustaining positive results, conservative management focus, and skillful deployment of assets, one is pressed to wonder, as some analysts have, why the stock hasn't broken through its 52-week ceiling. To be sure, a given sector of investors tend to stay away from low-cap, thinly traded companies in the gaming space. Others don't see a dramatic upside for the company given that its two properties are sited in what they may perceive as essentially ho-hum markets.
In previous articles about Monarch we've made the case that while Reno and Black Hawk, Colo., don't have the sex appeal of the Las Vegas Strip or Macau, they are both on the move demographically. In metro Reno-Sparks we're looking at up to 7,000 new jobs to be created by the coming Tesla (NASDAQ:TSLA) battery factory. Add to that general tech job growth and the indirect jobs those will add and you have the basis for a new economic vibrancy there. Add also the in-migration to Reno of an ever rising tide of Californians fleeing lifestyle and tax issues, and you have the makings of long-term upside for Monarch's Atlantis property there. Above all, the Reno property, the Atlantis, sits in the best neighborhood environs in the metro area, far away from the seedier parts of downtown where many competitors operate. The same set of favorable demos is at work in metro Denver -- population growth, high tech, and demographics solidly fitting a gaming profile.
So here we have a solid story of performance, forward-looking demo upside, sound financials and a family managed enterprise proven over time to have infused a strong service culture to their assets, and yet the stock hit a wall around the mid-$20s. A $9 a share move up from it's 52-week low wins nice brownie points in a year. But many gaming stocks also participated in a nice upside this year. We believe, however, that this company deserves an even richer valuation from the market.
If the economy holds up, Monarch will sustain its earnings growth in both its properties. The demos, the product and the management quality are in place. Projecting a continuation of that earnings growth we believe will bring the shares past its current consensus target to a new plateau. Going forward to 2017, we expect Monarch to move from $27 to $30 to $35 by Q3 of next year at the latest. Then, after the completion of its capex program (2019), which in process will convert nearly all its debt profile to accretive EBITDA, we see it moving even higher, possibly into the $40s.
Now that's our sense of the stock if nothing else happens. But its not. Plenty is already happening in the space, and we believe at some point much sooner, Monarch will be in a strong position to participate. And if there's an alpha in these shares, it's a bet that when the timing and numbers are right, Monarch will move a transaction and it shares will pop.
U.S. regional gaming is consolidating; Monarch can't escape the trend when so much money is coming to the table
Understanding the phases of history as U.S. regional gaming developed provides an insight into what could lie ahead. The 1990s were a time when new legalizations were the prime drivers of gaming shares. It was a simple calculation: The new markets were mostly underserved; the licensees were well-financed veteran operators. Put them together and, viola, you had built-in accretive EBITDA from day one. At the same time, you had the added flood of tribal properties competing with commercial casinos. This began to produce a degree of cannibalization, but it wasn't critical since geography held sway; tribal properties were usually far enough from commercial ones to control cannibalization to a reasonable degree.
That came to a screeching halt in the 2000s. That is when major metro areas, particularly in the Northeast, broke through legislative wariness and brought commercial casinos to mega markets like New York, Philadelphia, the Chicago metro area, etc. As they say in basketball, when a defense gets chippy, elbows and bodies bump hard. Well, gaming got chippy. Las Vegas Sands (NYSE:LVS) opened in Bethlehem, Pa., and MGM is about to open in metro Maryland/D.C., taking direct aim at Maryland commercial and smaller tribal properties in that state with a knockout property at National Harbor.
In New York, the $1 billion Montreign integrated casino resort is scheduled to open in March 2018. It's located in the Catskill Mountains, around two hours from midtown Manhattan, and much less from population-rich northern New Jersey. On top of that, MGM's planned Springfield, Mass., property, currently on track to open in early 2018, is an arrow pointed directly at the heart of the two Connecticut tribal properties' Hartford/New Haven customer base. And they now plan a fighting brand casino just over the border to counteract the MGM property. Not pretty.
Meanwhile, the aftermath of the 2007/8 recession was just beginning to get U.S. regionals out of harm's way, and the stirrings began that the traditional ownership structure of gaming companies needed an overhaul. The only way to thrive, many reasoned, was to monetize casino real estate by converting to REITs. So the first major gaming REIT appeared in Gaming &Leisure Properties, Inc. (GPLI) last year, which now has gobbled up the realty of Penn National Gaming (NASDAQ:PENN) and Pinnacle Entertainment, and, by all signs, is looking for more. This year, in response to shareholder pressure to unlock the value of its massive realty, MGM formed MGM Growth Properties, Inc. (NYSE:MGP) as a home for many of its legacy and regional properties.
Then we had, as we had forecast, the first of what we believe will be many acquisition or merger moves in the space. Earlier this year, ElDorado Resorts (NASDAQ:ERI) like Monarch, a super classy, family-run Reno-based casino operator announced it would acquire Isle of Capri Casinos (NASDAQ:ISLE), a move that would materially expand its geographic reach under a single corporate umbrella and produce synergies accretive to EBITDA very quickly.
Caesars (NASDAQ:CZR), under the crushing weight of its regional network which had been pummeled by recession and a private equity debacle, went bankrupt in January 2015. After a withering, nearly two-year long legal battle with its junior lenders, it now hopes to exit bankruptcy by early next year split into an operating company and a REIT. Its new owners, its bondholders, will naturally have something to say about that, but this remains fairly clear: Some of their current properties could well wind up for sale, if not in the bargain basement, then for certain at attractive price for would be buyers. Monarch could be a strategic buyer here.
Other small regional operators we watch like Full House Resorts, Inc. (NYSEMKT:FLL) priced at $1.50 at our buy signal and is now at $1.75. Isle now also has a transaction-minded CEO. Anyone who doesn't recognize that we are witnessing the beginning of a game-changing era in regional gaming stocks needs an eye exam. We expect the pace of change to speed materially after the Caesars exit. And we think that change will trigger a speedy roll-up of smaller regional gaming companies into either REITs or fewer, much bigger market cap companies.
That trend addresses the key issues: cannibalization, duplication of data bases, unlocking shareholder value, rationalizing operational functions, and better terms in financing as we can now expect the Fed to finally act on rates. No regional operator will be able to resist because the trend makes great financial sense for all involved.
And for solid, family-run companies like Monarch the options are many. Its current expansion program is well under way. Its financial structure is sound, so sound that it could even be considered a sitting duck for an activist investor or a larger competitor that could come calling. Conversely, Monarch is supremely well-positioned to be a merger partner with other regionals that offer complementary geography. Their Reno neighbors, the Carrano family who own Eldorado, made the move and I believe Monarch is next.
We think some kind of transaction looms for Monarch going forward. Right now, assuming nothing happens in the short term, investors are at little or no risk buying the shares at its current price under $27.
We think we'll be looking at another upside earnings surprise for Q4 this year and a continuation of that trend in 2017 -- even if there's no transaction news. That alone will enable the shares to break north of $27 and hover around $30 until the consolidation noise begins reaching closer to home. And what's that noise? For one thing, a potential acquirer looking at a strong asset base, chump change debt to assume and an upside when the Black Hawk property transforms itself into a full dress casino resort by 2019.
So we're holding to guidance on Monarch to move to $30 or higher based both on real performance and the growing prospect of a transaction next year. We like Monarch. We say it's a buy now.
Author's note: Howard Jay Klein, publisher of The House Edge, is a 25-plus-year veteran of the casino industry and now a consultant to that sector. He is not a CFA and his appraisals of gaming stocks are based on some standard metrics but also on a broad based research from his consulting practice and operating expertise in the casino space. His own gaming portfolio is in a blind trust to avoid potential conflicts of interest with client past, present or future.
Disclosure: I/we 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.