Monarch Casino & Resort (MCRI)

Holding the ace of spades

Monarch Casino & Resort (MCRI) is unique within the gaming industry for having a net cash position. With the industry potentially facing a slowdown, the robust financial position will serve it well – it can either take advantage of overleveraged rivals’ asset sales or increase returns to shareholders. The stock trades on an 11% FCF yield and also at discounts to history/peers on conventional multiples.    

History

MCRI’s roots go back to 1972, when the co-Chairmans’ father purchased a 142-room motel on the southern edge of Reno. The motel stayed under family ownership until 1993, when MCRI was listed on the NYSE with the motel as its main asset. Prior to the IPO, the motel had been expanded and renovated into a high-rise with 160 rooms and 16,000 square feet of casino space. It was renamed Atlantis. 

The IPO proceeds supported MCRI’s plan to expand Atlantis, which it did in two phases (1994 and 1999). The company also borrowed heavily to expand, with net debt-equity reaching 322% in 1999.

In 2007 it did another expansion of the casino and resort facilities.

The 2008 financial crisis hurt earnings though the company’s strong balance sheet (it had no debt at year-end 2007) limited the impact.

In 2012 it acquired the Riviera Black Hawk, a casino operator in Colorado, for $80 m. The price was attractive at ~8x earnings. In 2013 it began renovations of the existing facilities and, in 2016, construction of a hotel and additional casino space. A new hotel and additional casino space were open to the public in late 2020.

The lockdown in 2020 hurt financial performance that year. Since 2021 the combination of a slow return to normal leisure patterns and additional capacity have boosted revenue and profit.

Operations

MCRI has two operating assets:

·         Atlantis Casino Resort Spa – 61k square feet casino space, >800 guest rooms, restaurants, bars, etc. The casino has 1,250 slot and video poker machines, 33 table games, poker tables, a race and sports book (including mobile app), and other gambling facilities.

·         Monarch Casino Resort Spa Black Hawk – 60k square feet of casino space, >500 guest rooms, and the rest. The casino has 1,100 slot machines, 43 table games, a live poker room, sports book (including mobile app), and keno counter.

Business quality

Casino operators, including Monarch, typically produce low ROIC. Using 10Y averages, Monarch has produced 9% ROIC. For the US casino industry, the figure is about 5%. There are several challenges:

·         Asset-heavy balance sheets.

·         Limited differentiation.

·         Cyclicality.

·         Increased competition, both from other casinos and potential substitutes (online casinos, sports betting).

There is also the issue of regulation and licensing, which protect incumbent operators but in other ways add to their costs and limit their revenue potential.

For a commoditized business, operational efficiency is key. So how to measure efficiency and is MCRI delivering? Thoughts:

·         Asset Turnover – MCRI has typically been at the high end of the industry. Last year the figure was 0.7x compared to 0.2-0.6x for the bigger players.  

·         EBITDA margin – once again, MCRI has outperformed its more glamourous peers. In 2022 it stood at 33% versus a median of 25%.

The figures look good for MCRI. It has continued to gain market share in its two territories. In the Reno-Sparks market its share is 16% (from ~8% 20 years ago) and in Black Hawk it controls 29% (from ~8% 10 year ago). It is a simple formula – grow into demand and offer attractive amenities in a good location. Don’t overinvest or allow overhead costs to balloon. In addition, the smaller players like MCRI weren’t suckered into Macau, which in recent years has proven a drag on large operators.

Going forward, two major trends are shaping the industry:

·         Sports betting – in 2018 the Supreme Court ruled that states have the right to permit and regulate this activity. At the end 2022, 32 states plus the District of Columbia had legalized sports betting. Colorado introduced sports betting in 2020, and in Nevada it was legal prior to the court ruling.   

·         Online casino gambling – several states have legalized internet casinos (including New Jersey, Pennsylvania, Michigan, Delaware, West Virginia, Connecticut). Not surprisingly, growth has been rapid.

The key issue – do sports betting and online casinos increase the total gambling pie or do they cannibalize incumbents? Looking at states which were early to allow for sports betting and/or online casino gambling (check out ‘State of the States 2023’ by the American Gaming Association), the numbers suggest these new activities do not cannibalize traditional casinos, or if they do, any lost revenue is more than compensated by the new revenue streams.

Cyclical trends

For the industry, casino activity in both Reno and Black Hawk has slowed in recent months. Monarch revenue was essentially flat YoY in the Q ended September. Industry gaming proceeds for the month of October were poor in Black Hawk (-7% YoY) though resilient in Washoe County (+9% YoY).

Worth remembering, though, that the stock will likely bottom out prior to signs of improvement. This was the case in the last two major downturns:

·         The shares bottomed out at $3.80 in March 2009. By the time June 2009 results were released (August 10, 2009), which showed Q-Q improved financial performance, the stock was higher by ~190%.

·         During the pandemic, the low was March 2020. Due to the timing of lockdowns, there was no sign of recovery until 3Q 2020 reporting, released in November. At that point, the stock was up ~300% from the bottom.

Balance sheet health

MCRI enjoys a squeaky clean balance sheet, especially for a casino operator. It has a net cash position. Some potential contingent liabilities relating to lawsuits with a contractor have moved in favor of Monarch, as per news announcements of recent weeks.

Capital allocation

Historically it has focused on growth and did not return any cash to shareholders. Having achieved a net cash position at year-end 2022, it declared a 1x dividend of $5 in February 2023 and instituted a $0.30 quarterly payment. The $23 m in annual dividend payment, as implied by the quarterly figure, compares to free cash flow of $128 m in the past 4 quarters.  

It continues to express interest in further acquisitions. Surely some operators will feel the sting of higher financing costs and be forced to sell in coming months.

With a strong balance sheet and cash flow, MCRI is in a strong position to take advantage of any forced casino seller as rates rise, or simply increase returns to shareholders.  

Management & corporate governance

5 directors sit on the board:

·         John Farahi and Bob Farahi, co-Chairmen

·         3 non-executives, none of which appear to be credible counterweights to the family, in part due to their tenure (1 director has served since 1998, another since 2010).

The Farahi family owns ~30%. This includes Ben Farahi, who no longer has a formal role in the company. The 3 other directors own shares (worth $320k to $1.6 m).

The family runs the business, with John Farahi serving as CEO since inception. He is 75 years old, and younger brother Bob (President) is 72. Their lieutenants have been in place for several years.

John has earned between $2.2-5.4 m in the past 3 years, and Bob $1.1-1.9 m.       

Valuation

The shares trade on a discount to history and peers. EV/EBITDA is 7.6x versus historical at 9.2x. P/E is 15x versus 20x historical. Industry trades on 9.8x EV/EBTIDA and 19x P/E.

However, the most interesting sign of value is free cash flow yield. This sits at 11%. Ignoring cash inflow from a tax receivable, the yield comes in at 9%. Sector median is 5%.