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Bear of the Day: Churchill Downs (CHDN)

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Though the legal wagering industry in the US has been hindered by a host of moral and ethical concerns and an inconsistent patchwork of regulations, the tide is clearly turning, and there has been a significant expansion of legitimate options for placing wagers.

Almost everyone is familiar with the Churchill Downs Incorporated (CHDN - Free Report) as the home of one of the most popular and profitable sporting events in the world – the Kentucky Derby Horse race. Tens of millions of people tune into the “Run for the Roses” each May. It’s so famous that simply watching on TV – whether or not you choose to wear a fancy hat – is basically a rite of passage.

What’s less recognized is that in addition to the most famous track in the world, the CHDN company owns and operates four other tracks, six casinos, numerous OTB facilities in which horse racing fans can bet on far away races, as well as TwinSpires.com, the biggest online wagering business in the US.

Churchill Downs has been coy so far about their plans for expanding online wagering, and with good reason, it wouldn’t make sense to advertise that you’re the leader in activity that remains in a moral and legal grey area.

In May of 2018, the Supreme Court decided 6-3 that the regulation of sports gambling should be left up to individual states, significantly reducing the hurdles that an inconsistent patchwork of laws had placed in the way of legal sports wagering in most jurisdictions.

The case that the court decided was a challenge to a 1992 federal law that disallowed most states from permitting legal sports betting. The Professional and Amateur Sports Protection Act (PASPA) prohibited states from establishing or allowing betting on sporting events, but allowed for “grandfather” provisions that allowed four states to continue licensing and taxing sports gambling operations – most notably Nevada which has been allowing sports betting since the 1940s.

Though it’s impossible to exactly quantify the amount Americans are betting illegally on sports, the most accurate estimates are that something in the area of $150 billion is wagered each year on professional sports and high-level amateur competitions - like the NCAA tournament.

It appeared that everything was lined up for Churchill Downs, but the reality has instead been something of a disaster.

As tends to be the case when any (previously restricted) activity goes mainstream, there are a wide range of options for consumers. In keeping with the tradition of their iconic namesake facility, Churchill Downs has chosen to address the high end of the market.

Their state-of-the-art Derby City casino, opened in the Fall of 2018, is Louisville’s only legal gaming facility and features 900 gambling machines in 70 different themes as well as two locally-inspired restaurants and a vast gaming bar and outdoor patio spread over 85,000 square feet.

Derby City is only one of Churchill Downs’ physical facilities, but it’s an important testament to the company’s strategy. In an environment that is bound to include an increasing amount of options for gaming customers, CHDN was betting that those customers don’t simply want to make bets; they also want an all-inclusive entertainment experience that includes dining, music and other amenities.

The high-end, in-person segment of the market has been tough for the past year.

Online Presence

Named after the distinctive architectural profile of the racetrack itself, TwinSpires.com is Churchill Downs’ online portal for wagering. Offering gamblers the opportunity to watch high-resolution live video from five tracks, up-to-the-minute odds, handicapping data and access to all sorts of wagers – from the traditional “win-place-show” tickets as well as a wide array of more exotic bets.

The Financials

The most recent quarterly report for full-year 2020 shows just how much Churchill Downs has been negatively affected by the pandemic. Though TwinSpires revenues was up 39%, overall revenues were down a whopping 21% over the previous year.

A net loss of $81.9 million was a shocking reversal of a $137 million profit in 2019. The patchwork of state and local regulations around the US meant that many of the company’s properties were closed for significant periods.

Not surprisingly, future earnings estimates fell. It was a surprise however, CHDN shares continued to rise.  With the Zacks Consensus Earnings Estimate for the current quarter declining from $0.97/share to a loss of ($0.20) a share and the full-year consensus going from $5.91/share to $4.31/share, CHDN gets a Zacks Rank #5 (Strong Sell).

After an initial selloff, CHDN shares have actually risen 1% since the report on February 24th. Investors seem optimistic that in-person experiences will come roaring back in 2021, but that’s far from certain.

Owners of CHDN shares should consider themselves lucky that the markets haven’t punished the value of their holdings. They should also probably seek out better-positioned gaming stocks.

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