Churchill Downs' Dividend Safety Score Downgraded to "Borderline Safe" as Derby Will Be Held Without Fans

The pandemic has caused significant disruption for Churchill Downs' business. The firm's flagship event, the Kentucky Derby, was delayed from early May to September, hurting its horse racing operations (28% of 2019 adjusted EBITDA).

Meanwhile, casinos (58%) were forced to close temporarily. And although the online gaming business (14%) has continued growing, Churchill Downs' second-quarter revenue fell more than 60% and the company operated at a loss.

When we looked at the business in March, we decided to take a wait-and-see approach with the firm's Dividend Safety Score since the firm's overall financial health seemed to hinge on whether or not the Derby would take place, and what it might look like.

Since Churchill Downs pays an annual dividend, usually declaring its payout for the year in October, we figured management had time to gain clarity on the company's finances and horse racing operations before needing to make a decision on returning capital to shareholders.

On August 21, Churchill Downs announced that this year's Kentucky Derby would be held without fans. While wagering commissions seem likely to be strong, Churchill Downs won't realize fees earned from admissions, food and beverage sales, and other racing event-related services.

Coupled with an uncertain outlook for regional casino properties, it's not out of the question that management may choose to reduce or eliminate the dividend this year.

As a result, we are downgrading Churchill Downs' Dividend Safety Score to Borderline Safe.

From a financial perspective, the dividend costs only around $23 million per year. For a business that generated over $450 million of adjusted EBITDA in 2019, that's not a major commitment.

But with its casinos not operating at full strength and the Derby pushed out, Churchill Downs' 2019 dividend technically exceeded its earnings over the past year.

Source: Simply Safe Dividends
Analyst expect the Derby (plus a continued rebound in casinos) to restore profits in the year ahead, bringing Churchill Downs' payout ratio back to a healthy level. 

Management may be willing to look past the temporary setbacks of 2020 and maintain or even increase Churchill Downs' dividend.

After all, Churchill Downs' balance sheet and liquidity remain healthy. The firm had $649 million of cash with no long-term debt maturities until the second half of 2024. Churchill Downs was in compliance with both financial covenants on its revolver, too. 

However, a lot of discretion is involved in the dividend decision this year.

Ultimately, the dividend is not a major component of Churchill Downs' long-term total returns, as demonstrated by the company's relatively low payout ratio (in normal times) and dividend yield under 0.5%. 

No matter what happens to the dividend in October, this is not necessarily a reason to sell the stock.

Churchill Downs' long-term performance will be driven by continued interest in horse racing and the firm's ability to adapt its business model for the online world of sports gambling.

While it's still early days, there's no evidence yet that the Derby or horse racing in general has lost relevance due to the pandemic, and Churchill Downs already owns the largest online horse racing wagering platform in America. 

Investors who stay the course just have to be prepared for what could be a bumpy few quarters as the gaming industry tries to stabilize.