COMPANY UPDATE / ESTIMATE CHANGE Key Metrics CHDN - NASDAQ (as of 4/26/18) $274.85 Price Target N/A 52-Week Range $162.25 - $285.70 Shares Outstanding (mm) (basic) 14.4 Market Cap. ($mm) $3,958 3-Mo. Average Daily Volume 126,510 Institutional Ownership 86% Total Debt/Total Capital (3/18) 72% ROE (TTM ended 3/18) 26% Book Value/Share (3/18) $23.86 Price/Book Value 11.5x Annual Dividend & Yield $1.52 0.6% EBITDA Margin (TTM ended 3/18) 33% EPS FY 12/31 (non-gaap based, from contin. operations) Prior Curr. Prior Curr. 2017 2018E 2018E 2019E 2019E 1Q $0.13 $1.09 A 2Q N/A $6.50 3Q N/A $1.50 4Q $0.33 $0.91 Year $5.88 $9.00 $10.00 $12.00 P/E 46.7x 27.5x 22.9x Note: Quarterly EPS figures may not add to annual figure due to rounding. Revenue ($mm) Prior Curr. Prior Curr. 2017 2018E 2018E 2019E 2019E 1Q $168 $189 A 2Q $339 $353 3Q $197 $209 4Q $179 $189 Year $883 $930 $940 $1,050 Company Description: Churchill Downs Incorporated, headquartered in Louisville, KY, is a racing, gaming, and online entertainment company. It owns and operates several thoroughbred racetracks including its namesake facility, which hosts the annual Kentucky Derby. The company s other primary businesses are land-based casino gaming and the TwinSpires online wagering platform. Entertainment & Leisure Analyst: Jeffrey S. Thomison, CFA 502.588.9137 / JThomison@hilliard.com Institutional Sales Desk: George Moorin 502.588.9141 / GMoorin@hilliard.com J.J.B. Hilliard, W.L. Lyons, LLC April 27, 2018 Churchill Downs Incorporated CHDN NASDAQ Neutral-3 Strong 1Q Results CHDN s start to 2018 was impressive, handily beating our expectations. The 1Q is generally without live racing, so profit generation typically comes from the online wagering and casino segments. Mobile videogame developer Big Fish Games, which was sold early in the quarter, is treated as a discontinued operation and is removed from the presentation of results. Total 1Q revenues were $189.3 million, up 13% from a year ago. The street consensus estimate was $177.8 million. Adjusted EBITDA (earnings before interest, taxes, depreciation, amortization, and certain nonrecurring and non-cash items) of $49.2 million represented an increase of 36% from the year ago period. Adjusted EBITDA margin rose approximately 430 basis points. The company was active in the quarter. In January, it completed the planned divestiture of Big Fish Games for aggregate consideration of $990 million in cash. In February, the company completed a modified Dutch auction tender offer in which it repurchased nearly 1.9 million common shares at $265 per share for $500 million before expenses. Also in February, the company announced an agreement to acquire two assets that complement existing operations. We continue to view the company s prospects favorably and have raised our financial estimates. We are comfortable with the current three-segment operating structure live racing, online wagering, and casinos. In the near term, many eyes are on the upcoming Kentucky Derby, which historically provides significant financial contribution to 2Q results. This year s event at the namesake track could benefit from several off-season capital improvements, including additional capacity. Our Neutral rating on CHDN is based on valuation. We maintain our favorable view of the company, its portfolio of businesses, and management team. However, CHDN shares are currently above our preferred level for purchases. We could consider a rating upgrade at a lower valuation, assuming no change in company fundamentals. Our Suitability rating remains 3. Note Important Disclosures on Pages 5-6. Note Analyst Certification on Page 5.
Additional comments on 1Q. Results for 1Q 2018 were better than we expected, with growth from the online wagering and casino businesses and some improvement from the live racing segment, which typically generates a 1Q loss due to the seasonality factor. Presentation of results excludes Big Fish Games, which the company sold in early January 2018. We were impressed by 25% gains in adjusted EBITDA from both the TwinSpires online wagering segment and the Casino segment. At TwinSpires, the company benefited from higher online wagering volume resulting from an acquisition in 2017 and organic growth. Handle for the quarter rose 20%, above industry growth of 6%; this continued a demonstrated trend in recent years. At the Casino segment, most of the company s properties performed well by achieving EBITDA growth and market share gains. Contribution from the Oxford, ME property was boosted by the addition of a hotel in 4Q 2017. Also, segment results reflected growing contributions from partial ownership stakes in several regional gaming properties, including Miami Valley Gaming in Lebanon, OH. Adjusted EPS (excludes nonrecurring items and discontinued operations) were $1.09 versus $0.13 a year ago. However, we do not feel EPS is a major focal point among investors. Rather, we believe EBITDA is by far the most-watched financial metric due to industry norms and CHDN s debt and depreciation levels. The weighted average share count in 1Q was 14% lower than the year ago figure due to past share repurchases and the Dutch auction tender offer that was completed in the quarter. Financial condition. At the end of 1Q 2018, total interest-bearing debt was $886.6 million, or 72% of total capitalization. Shareholders equity at the end of the period was $343.6 million. At the end of the preceding quarter (4Q 2017) shareholders equity was $640.3 million. This reflects the recent repurchase of nearly 1.9 million shares through the Dutch auction tender offer. The period-end net leverage ratio (total debt less cash divided by trailing adjusted EBITDA) was 2.3x, a bit lower than our expectation. This figure was roughly 4.0x last year, prior to the recent Big Fish Games sale and related debt paydown. We believe the current level is conservative and provides considerable financial flexibility while the company pursues growth opportunities. Acquisitions announcements. During the recent 1Q period, CHDN announced a definitive agreement to acquire several assets from Eldorado Resorts, Inc., a casino/entertainment company headquartered in Reno, NV. Under terms of the agreement, CHDN will acquire Presque Isle Downs & Casino in Erie, PA and Lady Luck Casino in Vicksburg, MS. Presque Isle conducts about 100 days of thoroughbred racing per year and operates an adjacent casino with 1,600 slot machines, 32 table games, and a poker room. Lady Luck, adjacent to CHDN s Riverwalk Casino & Hotel, operates 620 slot machines, 9 table games, and an 89-room hotel. One interesting aspect of the Presque Isle purchase is that it could represent some opportunities as it relates to recently passed legislation in Pennsylvania authorizing real money online gaming, something new to the company. In theory, we believe CHDN s acumen with its TwinSpires online wagering platform could be a positive factor with potential entry into this business. We note permits/licenses from state bodies must be applied for and secured by potential operators. Based on these properties combined financial results, the transaction price of $229.5 million represents about 8.2x trailing twelve-month EBITDA. After expected synergies, the multiple would be 7.9x. We consider this a smart move and a reasonable purchase price. The Lady Luck Casino part of the deal is expected to close in 2Q 2018 and the Presque Isle part (though conditioned on the closing of Lady Luck) is anticipated to close in 4Q 2018. We have not factored these expected additions in our financial model, but will do so as the transactions are consummated. We feel the main benefit to CHDN will be the impact on 2019 results (expected full year contribution) rather than 2018 (partial year). Outlook. We continue to view CHDN s business prospects favorably and expect 2018 to be another year of record results. Planned additions and improvements to the namesake track in 2018 add growth potential to Kentucky Derby week and other parts of the racing year, while a new gaming center featuring historical racing machines (very similar to slot machines) is on schedule to debut in Louisville, KY in 3Q of this year. We expect continued outperformance from the TwinSpires online wagering platform versus the thoroughbred wagering industry. We also anticipate continued growth from the wholly owned casinos combined with contributions from equity stakes in various casino/hotel joint ventures. The aforementioned acquisitions would add to financial results, although we have not yet factored them into the equation. Hilliard Lyons Equity Research 2 Entertainment & Leisure
For all of 2018, we now project total revenue of $940 million, adjusted EBITDA of $320 million, and non-gaap EPS of $10.00. The increased revenue and EBITDA projections reflect strong 1Q results and our updated view on the balance of the year. Our EPS estimate also represents an increase from our last published figure; this mainly relates to benefits coming from recent share repurchases and a lower tax rate related to recently enacted tax reform. Although we consider our outlook to be favorable, we are mindful of issues such as start-up expenses for new businesses, competitive environments, regional economies, legislative factors, and total debt levels. We have not assumed future contributions from online casino-style gaming, a business the company continues to pursue yet is dependent on legislative approvals. To a degree, the same could be stated regarding online wagering on sports. Similarly, we have not assumed future passage of legislation that could allow traditional gaming operations at the company s Kentucky and Illinois racetracks. Stock price and valuation. CHDN shares are currently trading at 27.5x our 2018 EPS estimate; however, we feel an Enterprise Value/EBITDA (earnings before interest, taxes, depreciation and amortization) valuation approach is most relevant due to CHDN s debt levels and non-cash expenses such as depreciation & amortization. This measure focuses on the implied total value of a company (market capitalization plus net debt) relative to its cash flow generating ability and is commonly used in the analysis of many companies in the Entertainment & Leisure spectrum, including CHDN. As noted in Exhibit 1 below, Enterprise Value (using estimated year-end net debt figures) divided by our projections of 2018 adjusted EBITDA and year-end net debt is 14.5x. The multiple on our 2019 estimates is 12.7x. While the current EV/EBITDA multiple is above recent levels and historical averages, we believe the company s fundamentals, its financial condition, and growth opportunities appear to be stronger now than at any point in the company s history. Exhibit 1 Valuation Analysis (figures in millions except ratios, percentages, and per share data) 2019E 2018E 2017 2016 2015 Share Price (4/27/18) $274.85 Recent Diluted Share Count, estim. 14.5 Market Capitalization $3,985 Net Debt, year end ~ $600 $650 $1,078 $969 $1,107 Enterprise Value (EV) $4,585 $4,635 $5,063 $4,954 $5,093 Adj. EBITDA $360 $320 $286 $252 $231 year-over-year % growth 12.5% 11.8% 13.4% 9.2% 14.1% EV / Adj. EBITDA 12.7x 14.5x 17.7x Note: Valuation multiples are based on current market capitalization figures and projected year-end net debt levels. ~ Net debt figures represent balance sheet debt figures less cash and cash equivalents. Source: Churchill Downs Incorporated and Hilliard Lyons estimates Opinion. We rate CHDN Neutral due to valuation. We expect higher revenues, cash flow, and profits each year, yet recognize challenges such as a mature live racing industry and competitive environments and economic susceptibility at the regional casino business. We believe overall cash flow is on a growth trajectory and can allow for debt reduction, dividend service, and pursuit of growth initiatives in the years ahead. Hilliard Lyons Equity Research 3 Entertainment & Leisure
At the current price, we find the stock s valuation too rich for a purchase recommendation. If the stock price and valuation were to decline, we would consider a rating upgrade assuming no change in company fundamentals. Suitability. Our Suitability rating on CHDN is 3 on a 1-to-4 scale (1=most conservative, 4=most aggressive), and is based on factors such as industry and company risks, market capitalization, debt levels, and seasonality to the company s racing operations. Risks. In addition to legalities and contractual issues pertaining to alternative gaming, simulcasting, and advance deposit wagering, other factors that could affect the company s financial results and/or its stock price include: general economic conditions, technological advancements, new business ventures, the cost and integration of acquisitions, weather anomalies, insurance costs, the impact of gaming competition, legislative expenses, allocation of live racing days, overall popularity of thoroughbred racing, and competition for top horses and trainers. Exhibit 2 Business Segment Outlook (figures in millions except percentages) 2018E % chg 2018E % chg 2017 % chg 2016 % chg Net Revenues: Churchill Downs Racetrack $189.0 9.3% $172.9 7.2% $161.3 3.9% $155.2 2.7% Calder Race Course 3.0 11.1% 2.7 8.0% 2.5 (3.8%) 2.6 (3.7%) Arlington Park 60.0 3.3% 58.1 1.6% 57.2 3.4% 55.3 1.7% Fair Grounds 40.0 5.8% 37.8 4.1% 36.3 (4.5%) 38.0 (4.5%) Total Racing Operations 292.0 7.6% 271.5 5.5% 257.3 2.5% 251.1 1.2% TwinSpires 315.0 12.1% 281.0 9.9% 255.6 15.3% 221.6 10.2% Casinos - excluding JVs 419.0 14.2% 366.9 4.7% 350.5 5.3% 332.8 (0.0%) Other & Corporate 24.0 16.5% 20.6 7.3% 19.2 13.6% 16.9 1.8% Net Revenues from Contin. Oper. $1,050.0 11.7% $940.0 6.5% $882.6 7.3% $822.4 3.0% Adjusted Segment EBITDA: Racing Operations 98.0 7.7% 91.0 7.7% 84.5 6.0% 79.7 10.9% TwinSpires 80.0 12.7% 71.0 10.2% 64.4 14.6% 56.2 13.5% Casinos - wholly owned, estim. + 126.0 13.5% 111.0 4.7% 106.0 1.2% 104.7 2.4% Casinos - JVs, mgt fees, estim. + 64.0 16.4% 55.0 37.5% 40.0 89.6% 21.1 66.1% Other & Corporate (8.0) 0.0% (8.0) (8.0%) (8.7) (7.4%) (9.4) 80.8% Adjusted Segment EBITDA ~ $360.0 12.5% $320.0 11.8% $286.2 13.4% $252.3 9.2% Adjusted EBITDA Margins bp chg. bp chg. bp chg. bp chg. Racing Operations 33.56% 4 33.52% 68 32.84% 110 31.74% 277 TwinSpires 25.40% 13 25.27% 7 25.20% (17) 25.36% 75 Casinos - wholly owned 30.07% (18) 30.25% 1 30.24% (122) 31.46% 76 Casinos - includ. equity inv. in JVs 45.35% 10 45.24% 359 41.65% 385 37.80% 329 Total 34.29% 24 34.04% 162 32.43% 175 30.68% 175 ~ Adjusted EBITDA figures exclude nonrecurring items such as insurance losses/recoveries and racing industry trust fund proceeds, and also exclude items such as share-based compensation expense and pre-opening costs. + Estimated figures given assumptions regarding breakdown of our annual estimate for entire Casino segment Note: Figures reflect continuing operations only, with Big Fish Games (1Q 2018 divestiture) excluded from all periods. Source: Churchill Downs Inc. and Hilliard Lyons estimates Prices of other stocks mentioned: Eldorado Resorts, Inc. - ERI - $40.25 Additional information is available upon request. Hilliard Lyons Equity Research 4 Entertainment & Leisure
Analyst Certification I, Jeffrey S. Thomison, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject company(ies) and its (their) securities. I also certify that I have not been, am not, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation(s) in this report. Important Disclosures Hilliard Lyons' analysts receive bonus compensation based on Hilliard Lyons profitability. They do not receive direct payments from investment banking activity. Investment Ratings Buy - We believe the stock has significant total return potential in the coming 12 months. Long-term Buy - We believe the stock is an above average holding in its sector, and expect solid returns to be realized over a longer time frame than our Buy rated issues, typically 2-3 years. Neutral - We believe the stock is an average holding in its sector, is currently fully valued, and may be used as a source of funds if better opportunities arise. Underperform - We believe the stock is vulnerable to a price set back in the next 12 months. Suitability Ratings 1 - A large cap, core holding with a solid history 2 - A historically secure company which could be cyclical, has a shorter history than a "1" or is subject to event driven setbacks 3 - An above average risk/reward ratio could be due to small size, lack of product diversity, sporadic earnings or high leverage 4 - Speculative, due to small size, inconsistent profitability, erratic revenue, volatility, low trading volume or a narrow customer or product base Hilliard Lyons Investment Banking Recommended Issues Provided in Past 12 Mo. # of % of Rating Stocks Covered Stocks Covered Banking No Banking Buy 38 34% 11% 89% Hold/Neutral 71 63% 8% 92% Sell 3 3% 0% 100% As of 4 April 2018 Hilliard Lyons Equity Research 5 Entertainment & Leisure
Note: Price targets accompanying Buy ratings reflect a one year time period while price targets accompanying Longterm Buy ratings reflect a two to three year time period. Other Disclosures Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. Employees of J.J.B. Hilliard, W.L. Lyons, LLC or its affiliates may, at times, release written or oral commentary, technical analysis or trading strategies that differ from the opinions expressed here. J.J.B. Hilliard, W.L. Lyons, LLC is a multi-disciplined financial services firm that regularly seeks investment banking assignments and compensation from issuers for services including, but not limited to, acting as an underwriter in an offering or financial advisor in a merger or acquisition, or serving as placement agent in private transactions. The information herein has been obtained from sources we believe to be reliable but is not guaranteed and does not purport to be a complete statement of all material factors. This is for informational purposes and is not a solicitation of orders to purchase or sell securities. Reproduction is forbidden unless authorized. All rights reserved. Hilliard Lyons Equity Research 6 Entertainment & Leisure