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Price at writing $17.82 Signal: Buy
We have been watching the trading trends on Red Rock Resorts, Inc. (RRR) for some time. As of late, there appears to be growing bullish sentiment on the stock related to its 2Q20 performance. Like the entire gaming sector, it has been pandemic battered. But analysts believed the revenue profile of the quarter beat expectations of a lesser decline than forecast. This they reasoned, was a buy signal for the stock which has been trading ~$17 a share. Those results to us are not dazzling enough alone to warrant a move on the shares. But there are deeper rationales we see spread over a longer time frame that give us conviction that RRR may now be at an attractive entry point.
Data by YCharts
As with all gaming stocks, we always begin with management culture and DNA. On that level, RRR stands with its Vegas locals competitors in executing a strong customer service culture dating back to its earlier life when it was Station Casinos. That is directly linked to the Fertitta family which founded and still controls a significant chunk of the equity.
(Biographical note: The Vegas Fertittas are distant cousins of Tilman Fertitta, swashbuckling Texas entrepreneur who runs Golden Nugget (GN), Landry’s Restaurants (LNY) and the Houston Rockets NBA team. Tilman and his family are prominent members of Houston’s business and philanthropic communities as are their Vegas cousins.)
Tilman made an exchange of stock run at Caesars (NASDAQ:CZR) last year that quickly faded at Eldorado Resorts (ERI) when Carl Icahn entered the fray. This gave rise to speculation among the chattering classes of Vegas that a possibility of a merger between the cousins could loom at some point going forward. I don’t put high percentage odds on that at the moment but it is clear that both entities could gain financial strength by such a merger. Time will tell that story. Right now it’s a shrug and not a reason to get into the stock. Fertitta’s Landry’s Restaurants, as all restaurant chains, is facing immense pandemic challenges.
We like RRR’s DNA, a factor that does figure in a buy
Founder/patriarch Frank Fertitta Jr. (d 2009) came out of the Galveston Texas night club business back in the day. Fertitta arrived in Las Vegas in 1960 and beginning as a dealer, bootstrapped his way up to opening his first locals casino in 1976. Like all founders of the time he brought a strong understanding of customer service ethos with him. (Below: Frank Fertitta, Jr. (d. 2009) with sons who carry on a strong customer service culture). Source: Fertitta archives
Back in the day I met Frank on a business-related matter. A savvy, soft spoken entrepreneur, I sensed he had a similar outlook on customer service I found in companies like the aforementioned Boyd Gaming (BYD), Harrah’s (now part of CZR) and the Binion family (Horseshoe, now part of CZR as well) and the Carranos of Eldorado Resorts. Also a favorite of mine is Monarch Casino & Resort (MCRI) an enterprise of the Farahi family really killing it pandemic or not.
Fertitta was a very savvy, much beloved soul among his employees, which translates to the attitudes their customer-facing people brought to the casino floor, the restaurants, the showrooms. His legacy has been ably carried on by his son, Frank Fertitta III who presided over the transformation of the old Station Casinos properties into RRR, making money for his shareholders by carrying on the tradition that superior customer service starts with happy employees. There is no better grounding in the business to be had than beginning life on the casino floor.
2Q results, pandemic wounded, but show resilience as well
I realize there is something of a bizarre element in calling sharp declines in operating results as positives. But this is the case with RRR, which through a combination of reopening 6 of its properties at writing and scalpel like cuts of its headcount, including the corporate office, will yield $150m in savings. Total layoffs reduced staffing by 50% (redrockresortsinvestorroom.com).
Capex spend was $10.5m primarily related to maintenance and the rest were suspended. (Below: The flagship property: Quality assets in the entire portfolio. Source: RRR archives).
Here are a few key data points and our comments on 2Q20
The state ordered casino shut-downs on March 17. Re-openings for RRR properties began June 4th at Green Valley, Red Rock, Rancho Santa Fe Station, Boulder Station, Palace Station, Sunset Station and Wildfire and are continuing (latimes.com).
Net revenue was $108.5m for 2Q, down 77.5% or $374.4m vs. $482.9m for 2Q19. Net loss was $118m, a decrease from a net loss of $171m for 2Q19.
Adj. EBITDA was negative 111.4%.
However, in the small window between his past June 4th and June 20th,management reported net revenue was down 23.3% and adjusted EBITDA down 46.8%. EBITDA margin was up 2.132 bp to 45.9%.
This was the blended result of cost cutting and the 6 properties reopened signaling a small, but positive forward direction.
Part of this sprang from a trending younger patron base and a higher average spend per head. The older demo, which is the real bread and butter of the entire Vegas locals market, was lower or flat due to the pandemic. The key here is that post-virus, RRR will see the return of the older demo and add to it the new patrons acquired during this period producing a more balanced customer mix.
RRR’s marketing focus is on suburban Vegas customers – both retirees and working families.
Tribal presence
RRR manages the Graton tribal casino in northern California, which was partially opened in June as well. It produced a $5.2m EBITDA number, down from 2Q19’s $22m. After a 10-year legal struggle, the Mono Tribe of central California was encouraged by a ruling announced September 3rd by the state Supreme Court that has eliminated what both RRR and tribal officials had viewed as a major legal roadblock to their ambitions for a casino. With that out of the way now, the tribe expects to proceed to advance plans for a development at Madera, California, in the center of the state, around 164 miles from San Francisco and 225 miles from Los Angeles.
But the target here is likely to be Fresno, under an hour away from Madera, as well as Bakersfield, around 225m away. Collectively, these two central cities have a combined metro area population base approaching 1 million without depending on steady visitation from either of the state’s two mega metro areas. However, the driving time between the two mega-cities (San Francisco to Los Angeles) runs around 5 hours. Amtrak reports around 880,000 boardings in and out of those two central valley cities per year. Should the Mono tribe succeed from this point forward through the process of securing approval for a casino project, RRR will be the designated manager of the facility.
The cash position
There is no single metric during the pandemic more crucial to the post-pandemic status of casino operators than its current cash position. As of June 30th, RRR reported $270m cash on hand and drew on a revolver for $191m. Assuming the total cost cut target of $150m is achieved, we estimate roughly an 18-month or more solvency cushion for the company. Even taking the most dire prognostications of a second pandemic wave lasting through this coming winter and a worst- case arrival of a family of vaccines moving to mass inoculation levels, we see no threat to RRR solvency.
We think for 2020 the company could generate ~$60m in cash, pandemic impairment notwithstanding. Furthermore, taking a bull case under the assumption that a) a second wave will either not materialize, or even if it does, governments and medical authorities have broadened their knowledge base of the virus, that responses will be quicker and more comprehensive. That could mitigate second wave declines in revenue recovery. Or, b) that the family of vaccines will arrive ready to begin mass inoculations by the end of this year. The CDC has indicated the sequential mass inoculation program will begin with medical workers, first responders in police and fire, residents of nursing homes and the priority populations in the age groups from 65 up. As noted, the older demos comprise the core customer base of all Vegas locals casinos. RRR should therefore experience a faster recovery of revenue somewhere between 4Q20 and 1Q21 than will the Las Vegas strip properties.
Debt
As of 2Q, RRR carries $3.3bn in debt. Its quick ratio as of 6/20 stood at 1.79, somewhat above the gaming sector average of 1.21, but not what we consider dangerously so. Like all brick-and-mortar casino operators, it is capex-heavy by nature. Yet the $150m in projected cost cuts include long-standing labor and staffing levels, some of which will never return. This implies a management goal to totally streamline the entire operation to produce improved operating margins post pandemic and of course, bringing its debt profile into a more bullish perspective.
The under-the-radar case for RRR
The continuing bull cases for the stock emanating from many analysts mostly emerge from an analysis of its current response profile during the pandemic. What analysts see is a foundationally strong locals market-focused company with a time-tested management and a financial defense that includes both judicious cost cutting, capex postponement and a respectable cash pile to see itself through the crisis.
We agree with this assessment. But there are other factors we see as adding to a less apparent bull case longer term.
The stock is still cheap relative to the industry’s upside moves since the pandemic bottoms reached last March. The asset base is quality overall but it is moving lower. In 1Q20, it stood at $4.89b and fell to $4b in Q2. It could fall further in Q3 depending on the speed and depth of recovery in the Vegas locals market. We see positives in that regard ahead, but no big, propulsive catalysts that could materially increase positive sentiment in the short term. It is a value play at its price now. So our view is that if RRR continues stuck in its current trading range it could become a tempting target for a strategic merger with an operator who sees the long-term positive outlook for the Vegas economy.
Nevada’s population growth has accrued to a total of 13% over the last ten years, outstripping the national rate which has been essentially stagnant. In migration, especially among early retirees from major cities fleeing high taxes, social unrest and diminished lifestyle quality will bring more growth to metro Vegas. It now stands at around 2.3 million and is expected to grow to 2.5m by 2030 according to a UNLV forecast (thecentersquare.com).
Percentage-wise, the growth rate of metro Clark county has gone from a robust 5.3% in 2001 to 1.8% in 2020. But that represents only the early spearhead of pandemic induced in migration. And it also reflects a maturation and diversification of the economy becoming less dependent on gaming industry employment per se. What counts now is the demo of the emigres more than sheer numbers. Young retirees dominate, seeing Nevada as offering a less costly lifestyle and a variety of recreational diversions unique in the nation. As a harbinger of the maturation of the Las Vegas market, we have now seen two professional sports teams move in. The NHL Golden Knights hockey franchise and a week ago, the debut of the NFL Las Vegas Raiders. This is light years away from our memory back in the day when all four pro sports league presidents I had met with shuddered at the possibility of their franchises selecting Las Vegas as a home for one of their teams. No less being active partners in sports betting enterprises.
We believe both the NBA and MLB, with their television rating growth trends unimpressive and their fan bases either too young and less affluent (NBA) or continuing to dramatically age out (MLB) will move to bring some of their weaker franchises to Vegas. Then Vegas will have all four major pro sports equal to the top cities in the nation (usatoday.com).
This will add to the perception of Vegas as a desirable place to work or retire. That bodes bullish for locals casinos.
This reality cannot be lost on an industry in general which is rapidly consolidating. This trend will speed up post pandemic as the texture of visitation undergoes a change nobody can yet predict with any certainty. Sports betting infusing itself rapidly into the US regional casino space can only partially compensate short-term potential losses in tourism and conventions. Unlike its closest competitors like Boyd Gaming and Eldorado Resorts now merged into giant Caesars, RRR has no presence outside of Nevada other than its tribal management deal in California.
At its current trading range, RRR makes it either a tempting target for an activist seeking to merge it with an operator with a true national presence, or conversely, for RRR to make a run at small, high-quality regional operators like Monarch Casino & Resort, which share similar family management cultures. The landscape is dotted with small operators of one to four properties like Full House Resorts (FLL) which also trades very cheaply. This is the same scenario that brought Carl Icahn into the CZR calculus and ended with creating the largest US casino company in CZR.
We do not imply inevitability here. What we do believe is that the tide of consolidation and/or REIT spin-offs of casino realty will not only continue post pandemic, but increase. RRR has already restructured and streamlined its operating base. Its properties are well-rooted. Its customer service ethos among the best in the business. And its family dominated management and ownership profile understands this well.
It can continue to move aggressively in building its presence as a manager of tribal casinos. Or, it can recognize that the time may be at hand when the Fertitta family can make the kind of deal that would justify its heritage and culture and cash out. They can then remain solidly in operations and at the same time, unlock long-accumulated shareholder value for themselves and their investors. So we believe that RRR has a potent story above the radar and below it going forward and see the bull case many analysts have put forth as justified from an inside-the-industry perspective as well as metrics and data points.
With post pandemic recovery alone, we see a PT of $26.75 by 2Q21 for RRR
With possible transactions that may come into the crosshairs of activists or larger operators, the stock represents an even more attractive entry point at this time.
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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.