Sports Direct mounts a comeback and Cineworld’s latest acquisition fuels debt concerns

“Investors may be disappointed that we haven’t had a continuation of Friday’s impressive rally in UK equities on the same scale. However, they should also be relieved that we haven’t had a pullback with widespread profit taking,” says Russ Mould, Investment Director at AJ Bell.

“Many UK domestic names in the FTSE 350 index held their price on Monday, perhaps as investors took time to reassess valuations following the General Election rally. It will now be a case of looking for stocks for the best chances going in to 2020 rather than all stocks enjoying a re-rating.

“The FTSE 100 nudged up 0.9% to 7,422 thanks to some of the bigger constituents taking a small step forward including some of the banks, miners and tobacco stocks."

Sports Direct

“Can Sports Direct really elevate itself from the ‘pile them high, sell them cheap’ approach which has characterised Mike Ashley’s retail style to date?

“Today’s first half results at least offer some encouraging signs amid ‘green shoots of recovery’ in the once upmarket department store House of Fraser and a strong contribution from new Flannels designer clothing stores.

“A change of name to Frasers is being voted on today but it will take more than a surface level rebranding to set the business on a new path.

“Becoming the ‘Selfridges of sport’ will require a different skill set from the one which has helped Ashley go from a single store in Maidenhead in 1982 to today’s retail empire.

“You can understand the appeal of moving towards the premium end, given the potential for higher margins, but such a move is fraught with risk.

“Ashley will have to walk a tightrope to ensure he does nothing to undermine his premium brands which, after all, are what allow you to charge higher prices for products.

“He has already attracted some criticism for filling House of Fraser stores with discount goods and sportswear. Once you lose the shoppers prepared to pay for high end goods it could be a tough ask to win them back.”

Cineworld

“Making another large acquisition at a time when markets are already worried about debt levels is an extremely brave move by Cineworld.

“Its purchase in 2018 of US cinema chain Regal Entertainments raised many eyebrows because it meant the company would have very large debts for a number of years until it generated enough cash from operations to reduce borrowings to more comfortable levels.

“The number of short sellers – people betting on its share price falling – has been increasing this year, primarily over concerns about a weak film slate in 2019 and sky-high debt levels.

“Therefore news that it is now buying Canada’s largest cinema operator, Cineplex, for US$2.1 billion would suggest management are very good at shrugging off market concerns or they don’t realise they are walking further into the lion’s den.

“The deal does look attractive in that it strengthens the group’s position in North America and the valuation multiples for the acquisition price aren’t excessive. However, buying Cineplex will raise even greater concerns that Cineworld is trying to do too much at once.

“The Regal acquisition was all about breaking into a new geography and investing money to do up the acquired cinemas, as per the proven model from its existing European operations, and to benefit from economies of scale in areas such as buying cinema equipment.

“Cineworld says Cineplex’s estate is already well-invested but it still sees an opportunity to make money from introducing its membership scheme, technology platform and further strengthen its buying power.

“Ultimately Cineworld is continuing its land-grab exercise with the opinion that competition from streaming platforms such as Netflix isn’t anything to worry about, and that cinema will remain a resilient, affordable leisure experience in good and bad economic times.

“The trouble with Cineworld’s situation is that large amounts of debt can be a corporate killer if trading conditions deteriorate a lot. It is effectively betting that Hollywood studios will consistently release films we all want to see, and that a recession won’t hurt demand for a trip to the flicks. If this doesn’t turn out to be the case then Cineworld could start to sink under the weight of its debt.”

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