It's Time To Bet On Caesars Entertainment

J.B. Meathe profile picture
J.B. Meathe
197 Followers

Summary

  • CZR has many tailwinds working in its favor with increases in travel, relaxation of Covid-19 mandates, and continued expansion of room capacity.
  • Casino/Resort companies generally performed better than expected during the Great Recession.
  • When compared to industry averages and direct competitors, relative valuation multiples indicate that CZR is undervalued.
  • After conducting a valuation of CZR’s assets, I deducted that investors are currently not paying for 93% of the digital/other segment, implying that shareholders are receiving free revenue.
  • Assuming analyst consensus estimates in FY22/FY23 and a CAGR of 10% for CZR’s top-line in FY24 and FY25, my DCF model arrived at an intrinsic value of $74.23 (53.50% upside).

Bellagio + Cosmopolitan + caesars palace at night - Las Vegas

Eloi_Omella/iStock Unreleased via Getty Images

Investment Thesis

I rate Caesars Entertainment (NASDAQ:CZR) a buy due to their favorable position in casinos and online gambling, undervaluation based on absolute and relative valuation metrics, and the company's highly-valued operational assets. CZR has had a rough start to FY22 with shares down over 48% year to date. The poor performance of CZR's stock price can be partly attributed to the potential pitfalls of the American consumer, the company's aggressive margin targets, and continued losses in their online gambling segment. These headwinds have given potential investors an opportunity to buy CZR at a significant discount.

Industry Landscape

Since 2017, consumer discretionary companies such as CZR, TTWO, and INTU have all topped the S&P in May. Due to key business trends heading in the right direction, things will begin to look up for the casino company. Assuming that more Covid-19 variants don't disrupt operations, CZR has strong strategies that will drive future growth.

Since its 3Q21 inception, CZR's digital segment has netted over $1 billion in losses. Management expects cumulative losses of $1.5 billion before the digital segment turns profitable. However, the peak of the digital segment's losses is now behind CZR, which will further improve EBITDA and free cash flow. While not profitable, the addition of CZR's digital segment represents a significant opportunity for future growth with an above average TAM.

Market Intelligence firms are forecasting the online gambling market to grow at a CAGR of 11.9% from 2020 through 2030 (see below). In 2020, the U.S. online gambling market was valued at $8.7 billion. It is expected to grow to $29.97 billion by 2030. The legalization of Sports Betting was a huge victory for casinos. Sports betting continues to make up the majority of online gambling (see below). In 2030, sports betting is expected to make up over 50% of the total U.S. online gambling market. CZR continues to focus on partnerships to drive growth in online sports gambling. The company is committed to expanding relationships with leagues and professional sports teams. To this point, the company has formed partnerships with NFL, NBA, NHL, and MLB teams.

market expansion graph for online gambling

Online Gambling TAM from FY20 to FY30 (Grandview Research)

There are a number of tailwinds that are currently working in CZR's favor. Recently, New Orleans removed its mask and vaccine mandates. This will aid top-line growth for the company's Louisiana location, Harrah's Hotel and Casino. Another tailwind for CZR is the additional renovated room capacity in Atlantic City for 3Q22, enabling the company to serve more consumers during periods of significant demand.

A third tailwind for CZR is the rebranded and expanded Horseshoe Indianapolis for 2Q22. The rebranding and expansion of this location will allow CZR to attract more consumers, as well as meet significant consumer demand. A fourth tailwind is the completion and expansion of the Hoosier Park location for 4Q22, which will further attract consumers. Like CZR's Atlantic City location, the expansion of this location will drive top-line growth in times of significant demand. And finally, a fifth tailwind is the potential reopening of Horseshoe Lake Charles in 4Q22. All of these tailwinds will be very beneficial for CZR's top-line, margins, and sustainable growth.

Great Recession's Financial Impact on Casinos/Resorts

Because we are likely headed into recession in the near future, it's helpful for investors to know how the top-line of casinos and resorts will perform during times of economic hardship. During the Great Recession, large casino and resort companies generally performed better than expected. Out of the seven large casino/resort companies that I evaluated, four reported revenue growth from YE07 to YE09. The three that were negatively impacted reported decreases to their top-line. The extent to which the Great Recession negatively impacted these companies was fairly minimal with revenue decreases of 23%, 16%, and 18%.

In the midst of the 2008 Recession, Wynn Resorts saw an increase of 13% for their top-line from YE07 to YE09 (see below). Las Vegas Sands Corp. (LVS) saw a 55% increase in their top-line from YE07 and YE09 (see below). Golden Entertainment (GDEN) saw a revenue increase of over 290% from YE07 to YE09 (see below). And finally, Churchill Downs (CHDN) experienced a 14% increase in top-line growth from YE07 to YE09 (see below).

historical Revenue for wynn

Wynn Resorts Revenue- FY06 to FY09 (Bloomberg)

LVSC revenue during the Great Recession

Las Vegas Sands Corp. Revenue- FY06 to FY09 (Bloomberg)

gden revenue during recession

Golden Entertainment Revenue- FY06 to FY09 (Bloomberg)

Churchill downs revenue during great recession

Churchill Downs Revenue- FY06 to FY09 (Bloomberg)

In contrast, companies such as MGM Entertainment (MGM), Monarch Casino (MCRI), and Boyd Gaming Corporation (BYD) were negatively impacted by the recession. MGM experienced a 23% decrease in revenue (see below) from YE07 to YE09. MCRI experienced a 16% decrease in revenue from YE07 to YE09 (see below). And finally, Boyd Gaming Corporation experienced a 18% decrease in revenue from YE07 to YE09.

MGM revenue during great recession

MGM Entertainment Revenue- FY06 to FY09 (Bloomberg)

MCRI revenue during Great Recession

Monarch Casino Revenue- FY06 to FY09 (Bloomberg)

Boyds revenue during the Great Recession

Boyd Gaming Corporation Revenue- FY06 to FY09 (Bloomberg)

Relative Valuation

When comparing CZR's valuation multiples to those of peers and industry averages, the company is trading significantly lower and appears undervalued. CZR's forward P/E ratio of 9.07x illustrates that the company is trading lower than the industry average of 16.7x. In comparison to CZR's forward P/E ratio of 9.07x, the forward P/E ratio of MGM (32.5x), CHDN (18.5x), and WH (20.5x) also indicate that CZR is trading significantly lower than industry peers.

The company's forward EV/EBIT multiple of 11.3x indicates that CZR is trading significantly lower than the industry average of 29.9x. In comparison to CZR's forward EV/EBIT multiple of 11.3x, the forward EV/EBIT multiple of MGM (31.9x), CHDN (15.9x), and WH (17.63x) also indicate that CZR is trading significantly lower than competitors.

CZR's forward EV/EBITDA multiple of 7.1x (see below) indicates that the company is trading than the industry average of 9.9x. In comparison to CZR's forward EV/EBITDA multiple of 7.1x, the forward EV/EBITDA multiple of MGM (11.7x), CHDN (10.2x), and WH (16.9x) also indicate that CZR is trading lower than blue-chip companies operating in the casino/resort space. See below for further multiple comparisons for CZR.

multiples for companies similar to car

CZR Relative Valuation Multiples (Bloomberg)

CZR's forward EV/Revenue multiple of 2.1x indicates that the company is trading lower than the industry average of 3x (see above). In comparison to CZR's forward EV/Revenue multiple of 2.1x, the EV/Revenue multiple of MGM (3.2x), CHDN (4.4x), and WH (5.57x) also indicate that CZR is trading lower than direct competitors. And finally, CZR's Price/Book Value of 2.8x indicates that the company is trading lower than MGM (3x), CHDN (22.1x), and GDEN (3.7x). However, CZR is trading higher than the industry's average Price/Book Value of 2.6x.

CZR should not be trading lower than those mentioned without Las Vegas exposure. Casino companies with Las Vegas exposure warrant a higher multiple than those without. CZR's location in Vegas warrants a premium due to the city's high real-estate valuations and operating company asset sale prices. CHDN and MCRI don't have locations in Las Vegas and CZR is currently trading lower than both companies. CZR's premier location in Las Vegas drives significantly more foot traffic than casinos operated by CHDN and MCRI, which is why CZR should trade at a higher multiple than both competitors.

Valuation by Segment

value of each of czr segments

CZR FY21 Segment Valuation (Author)

To value CZR's assets, I multiplied the FY21 revenue of each segment and the average EV/Rev FY21 multiple of similar companies. At FYE21, CZR's casino/hotels segment were worth $43.1 billion, their food/beverage segment was worth $1.81 billion, and the digital/other segment was worth $2.87 billion (see above).

multiples that are similar to czr

CZR Relative Multiple Calculation/Averages (Author)

For CZR's casino/hotel segment, I calculated the EV/Revenue multiple of the casino/hotel segments for MGM, Marriot, Vail, Wynn, Hilton, and Wyndham. I then took the average of these multiples, arriving at 5.84x sales (see above). The companies that I used as relative multiples are all blue-chip casino/hotel companies that directly compete with CZR.

For CZR's food and beverage segment, I calculated the EV/Revenue multiple of DRI, CAKE, and BLMN. I then took the average of these multiples, arriving at 1.59x sales (see above). I used these companies due to the similarity of their food/beverage offerings to CZR. All of these companies offer casual and formal dining experiences with high-quality food offerings.

For CZR's digital/other segment, I calculated the EV/Revenue multiple of DKNG, PDYPY, and SCPL. I then took the average of these multiples, arriving at 2.73x sales (see above). After multiplying each segments 22E revenue by the average relative EV/Revenue multiple, we arrive at each segment's valuation.

After calculation, my forecasted asset valuation model for FY22 indicates that CZR's casino/hotel segment is worth $46.7 billion (see below), which represents valuation growth of 8.4%. Their food/beverage segment is worth $2.39 billion, which represents valuation growth of 32%. And finally, I arrived at an estimate of a $3.47 billion valuation for the digital/other segment at YE22, which represents valuation growth of 21%.

valuation of each of czrs business segments

CZR's Segment Valuation for FY22 (Author)

In order to calculate the implied value of CZR's digital/other segment, I subtracted the sum of the casino/hotel and food/beverage valuations from CZR's total enterprise value. I arrived at an implied valuation of -$3.25 billion for digital/other, implying that investors are currently not paying for 93.52% of the segment, receiving $1.19 billion in free revenue.

Discounted Cash Flow Analysis

forecasted revenue for fy22 through fy25 for czr

CZR's Forecasted Revenues (Author)

For my discounted cash flow model, I used analyst estimates of $10.7 billion and $11.9 billion for FY22 and FY23, respectively. I made assumptions of a 10% CAGR for revenue in FY24 and FY25. My DCF analysis arrived at an intrinsic value of $74.23 per share (53.50% upside from the current price of $48.36). Regarding the assumptions of costs and expenses, I used 3-year historical averages as a % of sales.

Over the past three years, CZR's average cost of revenues were 48% of sales. Their 3-year average of operating expenses were 35% of sales. Non-operating expenses were 5% of sales. Capital expenditures were 5% of sales. And finally, changes in net working capital were 10% of sales. Regarding terminal value, I used the 10 Yr Treasury Note as the perpetuity growth rate. After placing these assumptions into my DCF model, I arrived at the following cash flows for FY22 through FY25:

Forecasted cash flows for next 4 years

CZR's Forecasted Cash Flows (Author)

For my discount rate, I calculated CZR's WACC to be 10.97% using their current market capitalization and current market value of debt (illustrated below). To calculate CZR's Cost of Equity, I arrived at market risk premium of 4.42% by taking the difference between an expected market return of 7.50% and risk-free rate of 3.08% (US Treasury 10Y). To calculate the market value of debt, I used CZR's YE21 interest expense and the book value of their YE21 total debt.

WACC calculation for discounting cash flows

CZR's WACC Calculation (Author)

After applying a WACC of 10.97% to my forecasted future cash flows for CZR, I arrived at an intrinsic value of $74.23 per share (pictured below). This represents upside of 53.50% from the current share price of $48.36. My 12-month price target is well under the base case among Wall Street price targets, which vary from $90 to $149. Analysts are very bullish on CZR with the lowest price target of $90 still forecasting 86.1% upside. The median price target of $105.50 represents 118% upside. And finally, the highest 12-month price target of $149 represents 208% upside.

intrinsic value of czr after discounting cash flows

CZR's Intrinsic Value (Author)

Investment Risks

There are several risks to consider before investing in CZR. Despite the healthy state of the consumer balance sheet, the risk of recession is steadily increasing and may come sooner rather than later. Bloomberg sees the current probability of recession at 25%, while Goldman Sachs is even more pessimistic at 35%. This is very much a possibility soon given the geopolitical turmoil, inflationary environment, high oil prices, and potential corporate tax hikes. Given the healthy state of the consumer balance sheet, the next recession will hopefully be not as bad as the dot com bubble or sub-prime mortgage crisis. During times of economic hardship, people will be less apt to gamble if they are struggling financially.

Another risk of investing in CZR is if the company struggles to find buyers of its assets. CZR has relied on the sale of its assets to pay off the company's large amount of debt. Recently, CZR announced the sale of one of its sport-book operators, William Hill. CZR sold William Hill's non-U.S. assets for around $2 billion. If CZR can continue to sell its assets effectively, the company will thrive. Otherwise, the company could struggle given the large amount of debt on their balance sheet.

A third and final risk of investing in CZR is their elevated financial leverage. A high amount of financial leverage runs the risk of the inability to pay off interest payments on debt. CZR currently has a significant amount of debt on its balance sheet. While this does decrease the cost of CZR's capital structure, high financial leverage does pose several risks. If CZR's return on assets do not exceed the interest of their loan, it will greatly diminish the company's return on equity and profitability.

Closing Remarks

CZR is an exciting company with strong future growth prospects. They front-loaded all of their digital gambling and resort renovation costs, which placed a drag on profitability and free cash flow in the near-term. The majority of these investments and expenditures are behind CZR, which should improve profitability and FCF going forward. These capital investments will serve as solid foundations for CZR's long-term growth. When the digital segment becomes profitable, CZR will have a sustainable source of revenue in the rapidly expanding online gambling market. Additionally, CZR appears to be undervalued from a relative and absolute valuation perspective. I own CZR and will probably add to my position by the end of the week. Long CZR.

This article was written by

J.B. Meathe profile picture
197 Followers
MBA- John Carroll University. Fundamentals-based Investor with financial modeling experience. Strive to identify companies with valuable operating assets, healthy free cash flow/margins, and that operate within expanding markets.
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Disclosure: I/we have a beneficial long position in the shares of CZR either through stock ownership, options, or other derivatives. 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.

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