Boyd Gaming: Morgan Stanley Upgrade Earned, But True North Is Higher (NYSE:BYD)

Above: The Las Vegas locals market continues to benefit from migration from across the US, predominantly from California. – US Census Bureau.

• In an otherwise sluggish sector At this point, Morgan Stanley now sees a 23% upside to overweight with a PT of $74 for Boyd (NYSE:BYD). BYD’s online earnings are the key to the upgrade.
• BYD’s 2020 deal with FLUT for 5% of shares traded for access to its 28-property, 10-state portfolio for Fan Duel is one of the industry’s smartest deals by brick-and-mortar operators.

Premise: The latest update from Morgan Stanley analyst Stephen Grambling validated my own long-held bullish take on the stock. He moved his call on BYD from equal weight to overweight, indicating a 23% track ahead in 12 months to $74. According to NASDAQ reports, the analyst liked BYD’s EV/EBITDA ratio relative to peers MGM and CZR. The PT was raised from $59.38 to $74. Given the general slowdown in the sector, this change is welcomed by holders.

I agree that this change was well thought out given Grambling’s thesis. His upbeat take cites many elements of BYD’s business that I’ve long used to build my own case for the stock going back at least four years. He also cited BYD’s ownership of 90% of its own real estate as a plus. Most peers have long sold a large portion of their holdings to REITs. But the central catalyst is online growth.

Alpha Spread DCF value at writing $74.50 to target with upgrade Morgan Stanley PT. Best case is ~$87.

My own long-held thesis on BYD stock came out even stronger than Morgan’s. The price as of July 12, 2022 at the time of our writing was $49.67. We invoke similar arguments to support our positive PT. My own trailing SA on the stock has a PT of ~$78-$85 (last Feb 25) is up to ~$7 above Grambling’s. My higher PT comes from a more bullish view of revenue gains tied to declining competitive impact.

I think I calculated a bit more optimistically due to the fact that I made estimates of future business based on trading trends in the sector. But I also drew from within myself the years of business. I faced similar headwinds and competitive pressures as BYD, including the latest 2Q24 results.

Above: (Source: Sam’s Town Archive). It all started with one guy (Sam Boyd), one property and the customer focus that was vital in the local market.

In short: BYD’s 2Q24 results highlight the 224th quarter

EPS: $1.58, $967 million in revenue, a $57 million hit, virtually all of which came from online sports betting earnings. Overall, BYD posted a 5.5% increase in revenue, led by a solid 52% increase in its online business segment. This online performance is evidence, I believe, that the rapid growth of the company’s online business has offset much of the softness in some brick-and-mortar segments. It was somewhat soft across the regional segment and will work through the system as it always does, back to organic growth.

Source: BYD game archives.

Above: Like all great deals, it was a win-win for both companies.

Up: Up, yes, but plenty of room to run forward.

One key result we dug deeper into amid many strong upward segments like online was the aforementioned January-June 2024 diminution in the Las Vegas BYD locals market. This is a traditional strength of the company. During the earnings call, management attributed the decline in local earnings to an overall “competitive” environment.

I think we need to go down for a granular look at that segment. There are two culprits here. One is probably the leading edge of what I call bankroll fatigue. It’s a little-cited or understood effect that visits games in little-noticed cycles. It contains the seeds of a bit of recession fear in the public mind. But mostly players worry about playing too much. Gamers are “burnt” when it comes to this development. However, for BYD, I think the spearhead of local market softness also has a lot to do with the December 2023 debut of Red Rock Resorts’ (RRR) new luxury local property, Durango.

Above: The Durango is a new, luxury property that has taken part in varying degrees in the entire market of the two locals.

My most recent inquiries among industry friends in Vegas have validated my sense that the Durango has, in its infancy, poached share from BYD — and others. It has just left the initial period when curiosity visiting is at its highest.

We’ve seen this sequence of competitive pressure many times before. There are three phases of the impact of new properties of the same market on the existing market leaders. The first stage, Debut (December 23) to the first six months, showing considerable “must see” viewing of the new property. This is followed by the next six months, where trail visits have settled into a pattern. We’ve usually seen this next stage two when the vast majority of the game that sampled the new property begin to slowly return to where their mainstay was. And then we have the third phase when the process ends with a permanent loss of visits – usually not massive – either to sharing trends or a complete return to the previously selected property.

I cited this phenomenon from my personal archives in a previous post, but that was early on in Durango’s debut. This update from my discussions with industry friends in the locals market was done 10 days ago.

The 2Q24 earnings release indicated to me that the “must see” phase 1 was responsible for a significant loss in payer visits. It’s the first six months in Durango. This would put the local business impact of BYD behind the market share poaching. We are now in phase two with a steady stream of customer returns. Revenue reports generally show the rate of decline in business lost to failure. And clearly a “must see” tester return pattern. This will accelerate to Phase Three, which I believe we will see pre-covid BYD organic growth resume.

The overall regional performance of BYD properties across its system has many elements of bankroll fatigue mentioned above, based on the economic outlook of the regions.

financial; BYD has proven to be among the most astute asset allocators in the business. His transactional management mindset has served him well. His 2003 50% partnership with MGM for AC Borgata was dropped for $990 million, with much of the proceeds diverted to the acquisition of two Vegas locals’ properties that were priced fairly.

Although the company uses debt to finance current operations from time to time, its record is impeccable in repayment or refinancing. It has $280 million in cash and $3 billion in long-term debt. His effort to buy PENN Entertainment ( PENN ) with FLUT is rumored to be no fluke. They have the flexibility and resources to make such a deal. BYD owns 5% of FLUT’s equity, which it traded for Fan Duel’s access to its 28 casinos in ten states. It was a win-win. On a dollar-for-dollar basis alone, BYD’s equity in FLUT has risen dramatically in value since 2020. We remember BYD’s 2003 home run when its billion-dollar 50/50 partnership with MGM plus Borgata in AC led to a sale of his midfielder to his partner for $900 million.

BYD’s market cap at $5.88 billion is vastly undervalued just considering what 5% of FLUT could fetch either in a sale back to FLUT or on the open market.

Summarizing

Morgan Stanley’s upgrade (September 4/NASDAQ report) is very timely given the expected boom in NFL betting that is off and on. BYD has remained in position with FD is a proven leader in market share. Brick and mortar casinos support headwinds throughout the regional casino geography. Its financial structure is sound, its balance sheet is clean and, for the most part, in my view, the quality of its management is meeting and exceeding targets.

Don’t discount the chances of a Penn deal. Fits great everywhere. Of course, it is far from happening now and may never happen. But BYD and FLUT’s intention clearly signals that they are not content to rest on their laurels. As mentioned above, BYD cashed in on its Borgata partnership by selling it to MGM. If you see this as an entry into the gaming sector, you could find a better stock to be in right now. Location balance, financial stability and strategy that has worked for decades are now for sale at a good entry point.