Shares of Caesars Entertainment (NASDAQ: CZR) are down 24.64% year-to-date while the S&P 500 is higher by 7.57%, but some members of the buy-side community are enthusiastic about the casino operator’s prospects.
In a recent letter to clients, 1 Main Capital founder and portfolio manager Yaron Naymark noted the boutique investment firm established a new position in Caesars in the first quarter and that stock is now among the money manager’s top five holdings. One of the reasons for 1 Main’s enthusiasm for Caesars is the gaming company’s interactive arm, which includes online sports betting.
On the digital side, CZR has invested heavily in marketing and promotions to acquire customers over the last three years,” wrote Naymark. “Cumulative burn in this segment has been more than $1 billion in 2021 and 2022 combined. However, the digital business finally turned marginally profitable in 2023 and management expects that it should grow to $500 million of annual EBITDA within the next couple of years.”
When the Harrah’s operator reported first-quarter results last week, it told investors that some bad luck on the Super Bowl and March Madness hindered its interactive results to start the year, but it remains constructive in its long-term outlook for that business.
1 Main Capital Believes Caesars CapEx Will Pay Dividends
Like many of its competitors, Caesars is in the midst of significant capital spending cycle, including the introduction of new venues and enhancements to established gaming properties.
Caesars Danville in Southern Virginia came online about a year ago and the operator is in the process of transitioning Harrah’s New Orleans to Caesars Palace branding. The gaming company is also spending to spruce up casino hotels in Atlantic City, among other locations. Naymark believes those efforts could pay long-term dividends.
“On the physical side, CZR has deployed well over $1 billion into new and existing growth projects. This includes $650 million spent to build a new property in Danville, VA,” observed the 1 Main founder. “It also includes $400 million for upgrades to its properties in Atlantic City and an additional $400 million for upgrades to its New Orleans locations. Typically, the company expects at a 15%+ return on such growth projects, though they caveat that Atlantic City will probably come in below that figure.”
On the company’s earnings conference call, Caesars CEO Tom Reeg noted the operator could consider selling some “non-core” gaming venues that aren’t significant generators of free cash flow and such transactions could materialize at some point this year.
Speaking of Free Cash Flow…
Free cash flow (FCF) potential has been central to the Caesars investment thesis for several years and with the stock sporting a FCF yield of 12% and free cash expanding, some analysts believe the shares are undervalued.
1 Main Capital’s Naymark believes Caesars’ long-term FCF trajectory is compelling and could be significantly accretive to the share price.
“In a few years, CZR should be able to generate $2 billion annual free cash flow, or $9 per share. At that point, digital will still be growing nicely. As this happens, I believe that the stock should be substantially higher than its current levels,” concluded the investor.
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