Each year, punters bet millions on the Kentucky Derby.
Most would do better placing bets on the company that operates the storied Run for the Roses: Churchill Downs Inc. CHDN, +0.69%
A bet on this company is about much more than the old saw of gaming, or “the house always wins.” Yes, that’s an angle here. The company gets a vig on the bets on its horse races. And it owns casinos that post robust revenue growth.
But more interestingly, Churchill Downs shares should continue to outperform the S&P 500 Index SPX, +1.28% for these six reasons. Churchill Downs’ stock has returned 18% so far this year, while the benchmark index is little changed. Last year it was up 56%.
Read: Kentucky Derby: A 139-year-old horse is the key to a winning betting strategy
1. Churchill Downs has the kind of protective moat that Warren Buffett loves
The Kentucky Derby is the longest-running sports event in the U.S. The first in the set of races known as the Triple Crown, the Derby has run every year since 1875. No one will ever invent another Kentucky Derby. People love it. This is the kind of brand power that Warren Buffett likes to see.
Because the Derby is one of a kind, drawing celebrities from around the world, the venerable event commands huge sponsorship fees and broadcasting royalties, and a big take at the door. Last year, Churchill Downs events including the Derby brought in 19.6% of the company’s $882.6 million in revenue, or $172.7 million. The Derby also casts a magical aura on whatever else the company does, namely casinos and online track betting through a popular platform called TwinSpires.
Drink this: For Derby Day, here’s a Kentucky bourbon with an Alabama twist
2. An insider loves this stock
Churchill Downs executives politely decline to offer Kentucky Derby favorites.
“There is no sense in asking me for my picks,” says CEO Bill Carstanjen. “Because given my track record, no horse or their connections deserves to be called out by me as a favorite.”
But it’s pretty clear what one insider thinks of Churchill Downs stock. Director Richard Duchossois purchased $2.5 million worth at prices ranging from $241 to $272 a share in March and April.
That’s what I call a “sheer size” signal in the insider analysis I use in my stock letter, Brush Up on Stocks. Duchossois also has a pretty good track record, another quality I look for in insider buying.
Given all the other bullish factors in the mix here, it’s easy to imagine why Duchossois has been buying so much Churchill Downs stock, and why the stock is a better bet than the Derby, too.
3. Churchill Downs is a ‘one-percenter’ play
It’s no secret that there’s a growing division of wealth in the U.S. The super-rich are always on the hunt for splurges. Churchill Downs has been investing heavily to find more ways to oblige, and reap extra profits in the process.
Of course, the Kentucky Derby has always been a quintessential “one-percenter” event. The cheapest tickets cost about $80. That’ll only put you on the infield, where you’ll probably do better watching the race on a screen. An actual seat will set you back at least several hundred dollars.
But over the past year, Churchill Downs spent $37 million to roll out even more super-premium seating to garner extra one-percenter wealth. This year’s Derby marks the grand opening of 36 “Starting Gate Suites,” which cost $130,000 each. Despite the hefty price, they sold out fast, Carstanjen told investors on a conference call.
The company is also in the midst of spending $32 million to improve parking, transportation from parking areas and building aesthetics, all in the name of wooing the wealthy.
“We have bundled parking passes with our higher-end seats to a much greater extent than we ever could before, given these site changes,” says Carstanjen. These upgrades come on the heels of $35 million in spending to improve premium seating during 2015-2017.
The company has also been spiffing up casinos. For example, it recently added a “smoking patio,” or an outdoor gaming area where gamblers can light up, at its Oxford Casino in Maine. Improvements like these have been attracting more one-percenters. This helps explain the healthy 12% revenue growth and 36% profit margin growth at casinos in the first quarter.
“What is consistent across all properties is the higher-end customers have made more frequent trips,” Churchill Downs Chief Operating Officer Bill Mudd said on a conference call, explaining the juicy profit growth at casinos, which matters because casinos accounted for 52% of the company’s $189.3 million first-quarter sales.
Thanks in part to casino revenue growth, overall company sales grew 13% in the first quarter. And company sales grew 7.3% last year, to $882.6 million. That’s pretty nice growth, in an economy expanding at just 2%-3%.
4. To cover all bases, Churchill Downs is also investing down market
Smart managers always try to diversify, and the top brass at Churchill Downs are no different. They’re investing big to get more exposure to the hoi polloi among gamblers, too. The company is pouring $60 million into a gambling parlor in Louisville, Ky., near the Derby. Dubbed Derby City Gaming, the facility will offer “historical racing machines.” This is a form of video gaming where punters bet on old races displayed on video screens.
Also called “instant racing,” these machines randomly display races from a video library of thousands of old races. Punters can draw on old racing forms for guidance. Slot machines are illegal in Kentucky, but these machines will be cleverly designed to offer a similar experience. This site should open in the third quarter.
The company is also planning combined horse racing and historical racing machine projects at two other sites in Kentucky, one in the southeast corner of the state, and another across the border from Nashville, Tenn.
5. Churchill Downs may be the Amazon.com of horse-race betting
The company runs a high-growth mobile and online horse race betting platform called TwinSpires. It is the largest, legal mobile and online platform for betting on horse racing in the U.S. TwinSpires accounted for a third of revenue in the first quarter, when sales at this division grew 22% to $63.2 million.
A part of that came from an acquisition. But TwinSpires is also growing rapidly because of the same factor helping Amazon.com AMZN, +0.56% “We benefit from the trend of horse players moving their play online from traditional brick-and-mortar outlets,” says Carstanjen.
6. Two wild cards may provide some upside
The Supreme Court is currently reviewing a 1992 law limiting the spread of sports betting, called the Professional and Amateur Sports Protection Act (PASPA). A decision is expected this year. If the court eviscerates the law or chips away at it, it could clear the way for Churchill Downs to expand into sports betting.
“We have a lot of experience with different forms of wagering including online wagering through TwinSpires,” says Carstanjen. This gives his company the knowhow to branch out into sports betting, he says.
Next, there’s a chance Illinois may allow slot machines at race tracks, or “racinos.” This would help Churchill Downs, because it owns the Arlington International Race Course near Arlington Heights, Ill.
GAMCO Investors gaming sector analyst Adam Trivison thinks this alone could add anywhere from $6 to $28 of upside to Churchill Downs shares. The track and land are worth about $12 a share. They’re on the books at a much lower value, so they are a kind of “hidden value” inside the company.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested AMZN in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.