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Boyd Gaming: Sell-Off More Justified Than It Appears (NYSE:BYD)

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As I see it, there are three factors that can explain the decline in casino operator Boyd Gaming (BYD). The same factors that hold for the gaming sector and the market more broadly:

  1. The response to the COVID-19 crisis has led, and will lead, to near-term losses which need to be baked into the stock price. For Boyd, this obviously includes the current shutdown of the company’s properties nationwide.
  2. High unemployment and a mid-term recession add further profit and (possibly) multiple/valuation impact even once some semblance of normalcy returns to everyday life (ie, Boyd properties reopen).
  3. BYD, the sector, and/or the market were overvalued at February peaks.

For Boyd Gaming, I believe all three factors are at play. And taken as a whole, those factors suggest that a ~two-thirds decline in the stock price just since Feb. 20 is more justified than it might seem.

Obviously, reasonable investors can see this differently. Susquehanna came out with a $22 price target just last week, which suggests almost 100% upside from Friday’s close. And it’s worth noting that I liked Boyd last year, calling it my pick among U.S. operators. Still, this is a very different world than it was last year. In that world, I’m not convinced BYD is all that cheap, even at $11.

The Short-Term Impact

The short-term impact of property closures does not justify the steep decline in Boyd shares. Since the Feb. 20 close (after which Boyd released Q4 results), BYD has lost almost $2.7 billion in market value.

The closures only should, at least on paper, account for a small fraction of those losses. One analyst estimated last month that Boyd was burning $3.2 million a day in a note that came a few days after Boyd announced that by Mar. 18 that all of its properties would be closed.

That figure should come down. The Las Vegas Review-Journal has reported that Boyd told employees they would be paid through April 10. Furloughs may follow, dramatically lowering labor costs. But corporate expenses will continue, along with some level of maintenance. Rent expense to Gaming & Leisure Properties (GLPI) will run at $2 million a week, according to guidance from Boyd’s fourth quarter conference call.

Still, those figures imply likely less than $200 million in losses from the closures. (That’s even assuming the $3M+ per day rate holds for close to a month, with another ~60 days of closures at $1-$1.5M per day.) That’s less than $2 per share — about a 5-6% haircut from the February peak. A lost quarter of free cash flow, using 2019 figures, is another $85 million or so. Combined, the spend and the lost free cash flow justifies (on paper) roughly 10% of the decline in BYD. That’s solely the short-term impact of the COVID-19 response, unless that impact means casinos stay closed for the rest of the year. (Admittedly, that is not an impossibility.)

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And the good news is that Boyd seems almost certain to avoid near-term bankruptcy. The company drew down $660 million on its revolving credit facility in mid-March. Boyd closed 2019 with $250 million in unrestricted cash as well. Boyd should be able to last a year at the least (and probably two years) without reopening its properties. Casinos are covered for loans under the stimulus package as well.

Boyd may trip covenants on its credit facility, which has a maximum leverage ratio of 5.75x. But I’m loath to believe that lenders are going to push Boyd into bankruptcy and add that disruption to the difficult work of re-opening and recapturing customers in a tough economy. Worst comes to worst, Boyd probably has some levers to pull in terms of either raising cash from the feds and/or looking to GLPI for help (as Penn National (PENN) did last week).

Looking to 2021

With a reasonable degree of certainty, we can assume that the short-term cost of COVID-19 accounts for only a portion of the decline in BYD. And we can assume that Boyd is not going bankrupt in 2020.

From there, however, uncertainty dominates. It’s hard to estimate with any degree of confidence what casinos look like when they reopen. But there are very real reasons for concern.

First, the very structure of the business is troublesome even once the spread of COVID-19 is contained. It’s basically impossible to sanitize casino chips. The properties are not set up for social distancing. And Boyd’s properties in Las Vegas and regionally generally target the older demographic that appears more susceptible to the virus.

There’s going to be some loss of customers in the mid-term simply from COVID-19 fears. That alone is problematic for a business with enormous decremental margins, which are only amplified by the leverage on the balance sheet. (The equity slice now is barely one-fourth of enterprise value.)

But there’s also the impact of a potential recession caused by the current shutdown. That’s worry for the sector as a whole, but Boyd may have even greater exposure to economic troubles because of its Las Vegas Locals segment. That segment drove ~30% of profit in 2019, and is reliant in large part on a local economy still heavily dependent on tourism. (Boyd’s properties do garner some tourist/visitor traffic as well, but focus their marketing on metro-area residents.)

The financial crisis hit Las Vegas harder than most U.S. metros. It affected Boyd in a big way: Las Vegas Locals profit was halved between 2007 and 2010 — and grew barely 20% total over the next six years. It’s only due to acquisitions that EBITDA in the segment has returned to pre-crisis levels.

The Downtown business (a little of 6% of EBITDAR in 2019) will suffer as well, as it’s highly dependent on a charter service to Hawaii. I’d expect regional properties may do better in a recession (as was the case coming out of the financial crisis), but there will be impact there too.

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And one key problem is that Boyd does not appear to have much room left to find fat to cut in response. The company has done a fantastic job of improving margins since the crisis, including over 100 bps of expansion in 2019. But CEO Keith Smith admitted on the Q2 call that “it gets harder every month or every quarter to continue to find that next initiative that is going to drive more margin”, and on the Q4 call projected that the pace of margin expansion would slow. Boyd guided for Adjusted EBITDAR growth in 2020 of just 3% (at the midpoint), some of which was supposed to come from revenue growth.

To be sure, it’s difficult to model any business right now with any degree of confidence, and the casino industry is probably more difficult than most. But I personally believe Boyd is facing a difficult couple of years, not a snapback recovery after a few months’ worth of closures.

The Valuation Issue

There is a case that even those worries are priced in. Multiples for a cyclical business should expand at the bottom (in theory, at least; it quite obviously does not always, or even often, work that way in practice). BYD, meanwhile, is as noted down 69% from its highs. The stock trades at 5.9x the midpoint of 2020 Adjusted EBITDA guidance (subtracting the $104 million in annual rent expense from the Adjusted EBITDAR outlook). That’s a sharp compression from the ~9x multiple (based on 2019 figures) at which the stock traded at February highs.

But I’m on record as having a great deal of concern about multiples in the sector relative to cyclical fears. (To be clear, I’m not saying that to pat myself on the back. I was early in citing those worries and, that aside, made pretty much every late-cycle mistake in the book last year.) And that undercuts the simplest bull case for BYD.

That simple bull case is that, at some point, Boyd’s profits will return to the levels which the company originally expected in 2020. A vaccine hopefully will arrive, which can restore consumer confidence in visiting Boyd facilities. The economy will recover. Sports betting can contribute to the bottom line; as Boyd management noted on recent calls, the company benefits both through its partnership with Flutter Entertainment (OTCPK:PDYPY) unit FanDuel and via higher visitation and spend by on-premise bettors. Boyd didn’t expect material contribution until the end of this year, but that contribution will arrive at some point. It’s even possible that the COVID-19 crisis will boost sports betting revenue long-term, as suddenly financially-strapped states move more quickly toward legalization and/or add mobile betting to increase adoption.

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If Boyd can see that recovery and return to that ~9x multiple, the stock roughly triples. Even in that process takes a decade, investors buying now still earn double-digit annualized returns. But cut that peak multiple to ~8x, and the calculus changes notably. Add a couple of hundred million to net debt (required to get the company back to some degree of normalcy and positive free cash flow) and BYD’s returns are about 100%, not 200%. In the context of the near- and mid-term risks, there’s a significant difference between the two ceilings.

Obviously, neither model is foolproof nor precise, but the broader, directional point still holds. Some of the decline in BYD simply may have come from the fact that the stock was a bit overvalued in February (indeed, it had run past my target). Add leverage to the short-term issues and the mid-term recession risk and the 65%-plus decline here is not obviously unjustified. In fact, in that context, it’s reasonably logical.

In the mid-term, too, there’s a matter of confidence and valuation. We’ve now seen casino stocks get in the range of 10x EBITDA twice: in 2007 and in 2018-2019. I would wager it takes a long time for investors to get comfortable with those multiples again, or anything close.

And once ‘normalcy’ returns (whatever that looks like), I’m not convinced BYD will look all that cheap. From 2019 levels, cut Locals EBITDA by 30%, Downtown by 50%, and Midwest & South (the regional properties) by just 10%, and the stock is trading at about 7.5x EBITDA. It’s worth remembering that Boyd paid 7.0x in acquiring Peninsula in 2012 and 6.25x for four properties from Pinnacle in a deal agreed to in late 2017. The Pinnacle sale admittedly was driven by that company’s acquisition by Penn National (PENN), but historic M&A comps don’t require that BYD trade at 9x EBITDA or higher as it has on occasion in recent years.

Until that multiple returns, I don’t believe BYD stock rallies all that much. There’s simply too much leverage on the balance sheet and too much mid-term risk from elevated unemployment and changing customer behaviors. That combination is why the stock has fallen so far, so fast. And it’s why I think it will take some time for the stock to recover even a portion of those losses.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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