Overall, entertainment, casino and hotel operations have been volatile over the past few years, to say the least. They experienced an increase in activity before the pandemic locked down and closed most of their operations around the world and have has since been quite successful in returning to full swing.
Caesar Entertainment (NASDAQ:CZR) is no different. As one of the largest operators of casinos, hotels and golf courses in the Nevada area, the company has seen strong revenue increases in recent quarters as people returned to the world and wanted to make up for the past year and a half. confinements.
As the company progresses in these rather uncertain times, with a potential economic recession looming due to factors such as inflation and falling house prices, the company has the potential to return to profitability and generate significant cash. There’s just one problem – Caesars has too much debt.
Let’s explore why this is so important.
Improve the business model
After the company merged with Eldorado Resorts in 2020, they became one of the largest casino and entertainment operators in the world and also made acquisitions like William Hill to expand their gaming and reservations business segment . As a result, the company’s combined revenue has skyrocketed over the past few years and now stands at nearly $10.4 billion.
One of the more optimistic aspects of these acquisitions is that the companies are not yet done with the full merger cost savings that usually take a while. This means the company still has some way to go to reduce its revenue costs and operating expenses, both of which have increased in recent quarters.
After raising an additional $1.3 billion in cash during the merger in 2020 by selling some 23 acres of land on the Las Vegas Strip, the company is in a decent financial position when it comes to cash.
They currently hold just under $1 billion in cash and cash equivalents and have relatively low depreciation on over $17 billion in gross property, plant and equipment. Currently, the company reports operating income of $1.5 billion to $1.7 billion per year, which is astounding given the volatility it has faced over the past few years.
But factoring in the company’s long-term debt, that operating profit turns into a net loss of more than $1 billion a year due to interest expense. This is where the company loses its investment thesis.
Crippling profitability of the debt load
There are positives and negatives here. The silver lining is that the company is trying to pay down debt, especially high interest rates in the current rising rate environment. They have managed to reduce their overall indebtedness by approximately $400 million since completing the merger, from approximately $14.1 billion to $13.7 billion.
This high debt load means the company paid nearly $2.3 billion in interest charges in the last full year for reporting, a figure that isn’t expected to decline all that much. This is because even with their low indebtedness, interest rates continue to rise and the company still has a fair amount of high-interest and floating-rate debt, which increases with the federal funds rate.
I expect the company to bring in about $75 million less in interest expenses paid this year than last year, which really doesn’t have much of an impact. The fact that the company is going from an operating profit of over $1.3 billion to a loss of over $1 billion means it must prioritize reducing that debt to a level where it can become profitable again.
Can they do it?
It’s possible, but it’s hard
I surely believe that as the fundamentals of the business improve and the industry sees some rebound in terms of sales, as well as the company strives to reduce operating expenses and complete the cost of merging revenue savings – they can get to a place where they’ll soon be profitable.
This will allow them to generate more cash flow to reduce that debt. The somewhat negative aspect of their cost of revenue is that since the pandemic shutdowns have ceased, casino, hotel and gaming companies have been able to keep certain underperforming assets and parts of their casinos closed and so generate revenue with a higher profit margin.
Over time, I believe additional revenue will come with a lower profit margin, thus hampering some growth that analysts and the market expect it to bring as revenue continues to rise as the market will improve in the months and quarters to come.
Bright spots exist
While these negatives are quite alarming and it’s hard to see them hitting a low enough interest charge to become as profitable as analysts currently expect, there are positives.
One is the company’s focus on expanding beyond traditional hotels and casinos and into the legal online sports betting market, which has boomed in recent years. While the in-person casino gaming market is expected to remain rather volatile over the next few years, the online gambling market, which includes sports betting and other activities, is expected to grow at an impressive CAGR of 17.3 % until 2027.
Online sports betting has taken off in recent years with more and more states in the United States allowing some sort of activity and the company has partnered with various local businesses to tap into this market more effectively.
This, I believe, will help them offset some of their growth issues, should they occur, in cash from another downturn. Moreover, the margins of online gambling services are significantly higher due to the lack of necessary staff and the relatively low maintenance and infrastructure already in place.
Conclusion – Messy, but improving
It may seem obvious, but had it not been for the company’s indebtedness and resulting high interest payments in a rising interest rate environment, a long-term investment in the business would have been a no-brainer due to its increased organic revenue and expansion. in the online gambling market, which is expected to see higher margins with lower costs.
With analysts currently forecasting the company to post a profit next year, with EPS of $0.57, it’s hard not to believe that they will miss those expectations and subsequently see a steeper reduction. of the share price. As a result, I am avoiding the company at this time and will await further financial reports from the company before considering opening a position.
I am launching Caesars Entertainment with a cautious outlook until more information is presented and I can take a position if the company announces a bigger than expected reduction in debt or interest charges, even if it underperforms its EPS and current revenue expectations.