Once in a while, a student of an industry writes an analysis of profound significance.
Wells Fargo gaming equity analyst Dan Politzer has done that in a research note titled “US Gaming and the Hierarchy of Growth.”
Politzer’s basic conclusion is that growth of regional land-based casino gaming has stalled while digital is growing rapidly. No surprise there. And no surprise that the trend leads him to rate DraftKings and Flutter as overweight.
What is different from the observations of many others is a conclusion that could have important long-term impacts for investors in brick-and-mortar casino companies: “We are concerned land-based valuations may not recover to historic levels,” Politzer wrote.
Given that land-based stocks are selling at below historic valuations, that is a caution that should be considered by all gaming equity investors. Indeed, there is “a risk of long-term decline” for regional gaming, Politzer said. He defined regional gaming as commercial casinos outside of Nevada.
Let’s look at some of his numbers.
While U.S. gross gaming revenues have grown 5 percent a year since 2001, regional casinos haven’t done as well. About 50 percent of them have suffered revenue declines. That weakness has been masked by an average of 34 percent growth in adjusted EBITDA that itself is based on an 8 percentage-point growth in margins as operators cut costs.
However, there may not be “much left to cut” and operators “can’t cut their way to growth in perpetuity,” Politzer said.
The long-term trend is illustrated by revenue share. Regional casinos accounted for 40 percent of gross gaming revenues in 2021. That fell to 36 percent by 2019. It’s now 27 percent.
Further, what growth there has been is not attributable to existing operations. In fact, 70 percent of revenue growth since 2019 has come from new properties or new jurisdictions.
Looking forward, it appears regional casinos may be stuck at 1 to 2 percent annual growth, and that doesn’t bode well for expanding enterprise value-to-EBITDA multiples that are already 10 percent below historic levels, Politzer said.
Regional EBITDA multiples are 8.3 times vs. their historic 9 times. Politzer’s 2025 projections include Boyd at 7.5, Strip-regional hybrids Caesars and MGM Resorts at 7 and 6.4 times and PENN Entertainment at 6.8. So much for those of us who have long hoped gaming valuations would catch up with sister industries enjoying 10 and 12 and higher multiples. (It should be mentioned that other factors weigh in on stock prices and Politzer has overweight ratings on Caesars, MGM, Boyd and Churchill Downs.)
The exception to this valuation is Churchill Downs, which sells at 11.9 times vs. its long-time average of 10.3. Churchill is benefitting, in addition to the steady expansion of its Kentucky Derby franchise, from its commitment to systematically grow its historical horse racing business. That type of gaming has grown to $1.2 billion in revenue nationwide from a small fraction of that five years ago.
Elsewhere, Politzer is more optimistic about other sub-markets, notably the Las Vegas Strip.
So, the opportunity for investors is in digital, which grew gross gaming revenues 39 percent last year and is up 29 percent so far this year, Politzer said.
Of course, digital has its risks, too. But, Politzer concluded, the headwinds of increasing competition for regional gaming is greater than the regulatory and tax risks are for digital.
