Horse racing is a sport long in decline. Many racetracks are only able to survive because of their slot machine revenue. In the province of Ontario, where I live, the provincial government is currently looking at closing the slot machine programs at several tracks, in order to protect their existing casinos in Niagara and Windsor. Without the slot machine revenue, these tracks will surely close. It's a depressing reality that forced Churchill Downs (Nasdaq:CHDN) to remake its business model several years ago. Today, its business is thriving as a result. Trading just below $1 billion in market capitalization, Churchill Downs continues its marvelous run. Now is the time to buy, despite trading at an all-time high.
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There's no doubt that Churchill Downs' business model is tied to betting and wagering. Its four operating segments: Racing Operations, Online Business, Gaming and Other Investments, all involve, in some way, the making and taking of bets and wagers. While the horse racing industry continues to suffer at the hands of other entertainment choices available, its business model needs a relatively stable, if not growing industry, in order to present itself to the public. Without the Churchill Downs' racetrack itself, NBC Sports has no Run for the Roses programming each May when the Kentucky Derby is run and Churchill Downs has no spectacle to generate the $165.2 million from all-source wagering on-track and off, for the entire 13-race card. Therein lies the risk of owning its stock. At present, just $53.2 million in revenue (Harlow's Casino) is unrelated in some way to horse racing. I don't think it's a concern mind you, but it's always good to know.

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Just as diversification is important when investing in individual stocks, so too is it important when it comes to Churchill Downs' viability and success as a business. As recently as 2004, the company's revenue from slot machines was less than $13 million. Flash forward seven years and gaming revenues were $212.6 million in 2011, 31% of its overall business. More importantly, gaming contributes 36% of its EBITDA profit at a 26.8% margin. In 2007, it launched, its first owned and operated advance-deposit wagering (ADW) platform. Five years later, TwinSpires and its other ADW platforms are generating $800 million in wagers, 25% higher than Churchill Downs itself. Even better, the online business' commission on the wagers was 19.5%, more than double Churchill Downs' take. In just two years, its net pari-mutuel revenues increased 138% while its EBITDA profits have grown 171%. While still only the third largest source of revenues and profits, it's coming hard and that's impressive, considering it didn't really exist before 2007. It seems to me that Churchill Downs management has figured out how to make the best of a difficult situation.

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Churchill Downs and Peers


Churchill Downs (Nasdaq:CHDN)


Las Vegas Sands (NYSE:LVS)


Wynn Resorts (Nasdaq:WYNN)


MGM Resorts (NYSE:MGM)


Penn National Gaming (Nasdaq:PENN)


Why Buy

While I love the business, its stock is just 2.25% from an all-time high of $60. As the markets hit their lows in March 2009, Churchill Downs still managed to trade above $20. For whatever reason, this is one resilient stock and that's demonstrated in its 10-year total return, which is 6.09%, 173 basis points higher than the S&P 500. It's done a good job keeping up with the index and its gambling peers. In fact, $100 invested in Churchill Downs on Dec. 31, 2006, was worth $129.23 on Dec. 31, 2011. In comparison, $100 invested in the Russell 2000 was worth $100.77 and the same $100 in the Morningstar Gambling Index was worth just $58.04. What stands out for me is the fact it's gaming and online wagering is completely changing the ebb and flow of its revenues and profits. Take the latest fourth quarter results as an example. It tends to lose money in the final quarter of the year. However, these newer higher margin businesses helped produce a profit of 25 cents a share. Analysts will eventually catch on that its business is changing but it's nice to see nonetheless. As margins continue to grow, so too will its earnings. If anything, its business today, offers shareholders a greater moat than it ever has.

The Bottom Line
With cash flow stronger than ever, I don't see much downside in its stock. It represents a safer bet than many of the huge casino operators because its debt is minimal in comparison. If you're a conservative investor interested in decent growth at a reasonable price, I'd place my bet on Churchill Downs.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.