(By Mani) Isle of Capri Casinos, Inc.
) is an underrated growth story given its diversified model focusing on niche gaming markets and value-oriented customers, with growth opportunities in place coupled with a strong cash flow.
St. Louis, Missouri-based Isle of Capri Casinos is a regional gaming operator with operations primarily in the Midwest and southern United States. The company owns and operates 14 properties in Louisiana, Mississippi, Missouri, Iowa, Colorado and Florida.
In addition, the company is currently developing its fifteenth property in Cape Girardeau, Missouri, which is expected to open by November 1, 2012.
While other operators focus on new, flashy casinos in large gaming markets, Isle effectively serves the value-oriented customer typically in smaller markets with little competition. This has allowed the company to generate a relatively stable stream of earnings, while its diversification has protected it from increased competition in select markets.
One of the keys to the company's portfolio of properties is its geographical diversification as no casino contributes more than 13 percent of property EBITDA. The company is expected to further diversify upon the opening of Cape Girardeau.
"Diversification is important, in our view, as it reduces the impact of any one market or casino disrupted by new competition," RBC Capital Markets analyst John Kempf said in a client note.
The second attraction of Isle's portfolio is that most of its properties are located in smaller, niche markets with little competition. This allows the company to enjoy higher EBITDA margins.
The company's properties with the highest EBITDA margins are typically the ones that are the only casino in its market. Further, these markets are generally small in size, so the threat of new competition is unlikely as it would be difficult for a competitor to justify the capital investment required to compete effectively in such a small market place.
"At current valuation levels, we believe investors are buying into Isle with an attractive upside and limited downside," Kempf said.
The current stock price gives little credit for the November opening of Cape Girardeau, or organic earnings growth. Isle is not facing the same level of increased competition as other regional gaming companies. Only one casino, Kansas City, is grappling with new gaming supply, although its results have been surprisingly good.
"We like under-appreciated gaming stories, especially one like ISLE, which typically flies well below the radar screen," the analyst noted.
The company should begin generating substantial free cash flow following the opening of Cape Girardeau, which could lead to further growth opportunities.
"We estimate Cape Girardeau could add $0.63 of equity value per share, utilizing a 6.5x EBITDA multiple," Kempf added.
In addition, credit metrics continue to improve rapidly, which further supports higher valuation levels. The company's earnings growth will stand out among regional gaming companies, which should provide a catalyst for stock price movement.