Red Rock Resorts, Inc (NASDAQ:RRR) presents an intriguing investment opportunity with a seasoned management team and positive key indicators post-Corona crisis. Their shareholder-centric approach bodes well for potential returns in the future. However, there is currently one aspect that impedes my ability to invest in the company at this time. In the following sections, I will guide you through my thesis to highlight the essential facts and considerations.
Red Rock Resorts, Inc. is a holding company that primarily owns and operates a portfolio of casino resorts. The company operates several casino resorts and entertainment venues in the Las Vegas metropolitan area, including the Red Rock Casino Resort & Spa, Palace Station Hotel & Casino, and Boulder Station Hotel & Casino. Presently, they boast a portfolio with 6 major properties and 9 smaller ones. Red Rock Resorts offers a variety of gaming, dining, and entertainment options, as well as accommodations for both leisure and business travelers. The company is focused on providing high-quality, value-oriented experiences to their guests.
Nevada is an ideal location for a gaming business due to several factors. Firstly, the state's stringent regulations and laws, such as Nevada Law SB 208, make it difficult for new competitors to enter the market, providing established businesses with a secure operating environment. Secondly, Nevada has experienced tremendous growth over the last two decades and is poised for continued growth in the future, providing a favorable outlook for businesses in the state. These factors, combined with Nevada's reputation as a hub for entertainment and tourism, make it a prime location for a thriving gaming industry.
The two screenshots above showcase the local gaming market, which is a key target audience for Red Rock Resorts. This market presents a strong future growth opportunity, as evidenced by the high household income and substantial amount of money spent on gaming by local residents. Red Rock Resorts is well positioned to tap into this lucrative market, providing a promising outlook for its future growth and success. Additionally, Nevada is the most popular destination for inbound migration in the United States and its population has grown by nearly 50% within a period of 20 years.
Currently, Red Rock Resorts has two exciting projects in development. The first, the Wildfire Fremont, is set to open its doors in February 2023, bringing a new level of excitement to the local gaming market. The second, the highly anticipated Durango project, will debut in the fall of 2023. These two projects demonstrate Red Rock Resorts' commitment to growth and innovation, positioning the company for continued success in the future. Furthermore, Red Rock Resorts possesses a significant opportunity for growth with its 634 acres of undeveloped land, which is currently valued at between $854 million and $1.1 billion. According to the company's recent Q3 earnings call, the plan is to fully establish the Durango project and ensure its stability before proceeding with further development of additional properties. The management also expressed confidence in their ability to confidently double their portfolio by the year 2030.
According to their statement in the Investor Presentation, they have achieved a 20% IRR on their greenfield developed properties since 1993. However, when calculating the 5-year average ROC, it stands at around ~12%. Of course, this has suffered during the coronavirus years, bringing down the average, but even before coronavirus, the return on capital was not really outstanding. Since 2021, however, there has been a clear upward trend with ~20%+. So this value could significantly improve in the coming years. With ample opportunities for growth, an ROC in the twenties holds the potential to generate substantial value-addition in the future.
The seasoned management team boasts a deep understanding of the Las Vegas and Valley markets, with an astute knowledge of prime locations for casino development. Their extensive experience in the Las Vegas casino industry serves as a strong foundation for their success. Additionally, the company exhibits a strong commitment to its shareholders, evident in its current dividend rate of approximately 2%. They have demonstrated this by distributing $81.6 million to shareholders via dividends and executing $642 million in share repurchases. There remains $313 million available under the current share repurchase plan. Representing a proportion of roughly 6.7% of the current market capitalization, this contribution has the potential to exert a meaningful influence. In the accompanying illustration, it is evident that the number of outstanding shares has experienced a notable decrease in recent years.
The Gross Profit margins consistently maintain a strong range of 60% to 65%, with only minor deviation during the challenging Corona years. A noteworthy accomplishment is the exceptional growth of Operating Income margins since 2021, reflecting a remarkable improvement in the Total Operating Expenses ratio. This has resulted in Operating Income margins that are consistently above 30%.
They boast a commendable 3.8x net leverage and 6.8x interest coverage ratio, which aligns with the standards of the competitive casino industry. While some industry players may outperform in these metrics, others may fall short. This places them in a position of being well-balanced within the industry.
A noteworthy aspect to consider is the valuable potential of the company's undeveloped acres of land, valued at a range of $8.23 to $10.41 per share. This represents a significant proportion of 18% to 23% of the current share price of $45. An examination of the Pretax multiplier of approximately 6 and the EV/EBIT of around 9 highlights the favorable value of the business. A Pretax multiplier below 13x is considered attractive by many investors, making this investment opportunity even more appealing with a multiplier well below the threshold.
A challenge that may be perceived with the business is its complex organizational structure. As the following screenshot and quotes from the recent 10-K will illustrate, the nature of Red Rock as a holding company may result in some complexities that are not typically encountered in other companies. While some individuals may have a clear understanding of the implications of the complex organizational structure of Red Rock, it may prove challenging for others to fully grasp its potential impact on the business. As an investor, I prefer companies with a simpler structure and greater transparency, making it easier to predict future outcomes and assess key variables.
In addition, because the Principal Equity Holders hold most of their ownership interest directly and/or indirectly through Station Holdco, rather than through Red Rock, the public company, they may have conflicting interests with holders of shares of our Class A common stock.
We will be required to pay certain of our pre-IPO Owners for certain tax benefits we may claim arising in connection with the reorganization transactions, and the amounts we may pay could be substantial.
Aside from the intricate organizational structure, the company faces potential future risks regarding the substantial capital required for proposed development, expansion, acquisition, or refinancing efforts. Although borrowing is necessary to secure these funds, the company does have a credit facility in place.
As demonstrated in my analysis of Churchill Downs Inc. (CHDN) and Monarch Casino & Resort Inc. (MCRI), the gaming sector presents numerous attractive investment opportunities and well-performing companies. And Red Rock Resorts showcasing a commitment to their shareholders, a knowledgeable and capable management team, and highly popular casinos among the local community. Furthermore, the company has demonstrated impressive resilience with improved margins and revenue growth following the challenges posed by the COVID-19 pandemic.
A closer examination of the Pretax multipliers and EV/EBIT reveal that the current price of the company represents a favorable value proposition. It is likely that the company is undervalued by a little bit. While I find the organizational structure to be a hindrance, I acknowledge the potential for growth as demonstrated by the abundance of opportunities for new projects and ample available acreage. If the company were to improve its return on capital in the upcoming years, it would be a noteworthy development as it would provide a solid foundation for future growth.
For investors who can look beyond the organizational structure and see potential for further improvement in key metrics, Red Rock Resorts may offer a lucrative investment opportunity. Despite my criticism, I believe there remains a significant possibility for market-beating returns in this company. But at this point, I consider Red Rock Resorts as a "hold" investment.
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Disclosure: I/we have a beneficial long position in the shares of CHDN 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.