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So many reasons to invest in Cineworld now
A very promising film slate in 2018 and a clear opportunity to improve earnings from its newly-acquired chain of 561 cinemas mostly in the US are good reasons to buy shares in Cineworld (CINE).
Also supporting the ‘buy’ case is the fact its shares are trading on an approximate 30% discount to its global peers, according to analysts at HSBC.
WHY ARE ITS SHARES CHEAP?
Cineworld is trading on approximately 12 times forecast earnings for 2018, falling to a price-to-earnings (PE) ratio of approximately 11 in 2019.
In comparison, HSBC calculates global peers trade on circa 17 times earnings for 2018, a level at which Cineworld used to trade before it bought Regal Entertainment earlier this year. Cineworld’s 10-year PE average is 14-times.
Owning Regal instantly made Cineworld the second biggest player in the US. Unfortunately many investors lost interest in its shares as buying Regal Entertainment dramatically pushed up debt levels and there are also concerns the US market lacks growth opportunities.
You could argue the shares deserve some sort of discount because of the elevated debt, but we don’t believe they deserve it on such a scale as is currently seen.
We think the business has the right qualities to quickly pay down debt and drive up earnings from the US estate.
HOW WILL IT WIN BACK THE MARKET’S FAVOUR?
The sharp drop in the share price, as illustrated by the accompanying chart, can be explained by negative market reaction to the Regal deal and the subsequent heavily-discounted £1.7bn rights issue to help fund the £2.6bn acquisition.
Stockbroker Numis estimates Cineworld currently has a net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) ratio of 4.4-times, a considerable jump from its 1.2-times level prior to the deal.
If you’re not familiar with this ratio, in general investors like to see a net debt-to-EBITDA level below 3.0-times. Having a high debt level can be negative if there is a downturn in economic conditions or a sudden drop in earnings, as a company would come under pressure in terms of being able to service its debt.
Numis believes Cineworld’s net debt-to-EBITDA ratio will fall to 3.2-times by the end of its 2019 financial year and keep falling thereafter.
The business is highly cash generative and is expected to self-fund a major investment programme in the Regal estate over the coming years – which is key to the investment case. Cineworld is going to refurbish many of the Regal cinemas to make them a more pleasurable experience.
Chief financial officer Nisan Cohen says previous refurbishments across the company’s cinemas in the UK, Central Europe and Israel have helped to deliver a new experience so the customer is prepared to pay more. For example, Berenberg’s leisure sector analysts note Cineworld has consistently achieved returns on invested capital in excess of 20% for UK refurbishments.
Cohen says Regal has only invested in reclining seats in the past few years. This gives Cineworld the opportunity to spruce up lobbies, bars and introduce digital screens. Ultimately we believe these improvements could help Cineworld take market share from rivals.
OTHER VALUE DRIVERS
HSBC’s leisure analysts believe Cineworld could deliver 70% to 80% of $100m targeted synergy benefits from the Regal acquisition in the first year of ownership, ahead of the 50% delivery guided by the company. Regal will also save circa $60m a year on its tax bill thanks to Trump’s tax reforms.
Removing duplicated functions and plc costs following the Regal deal, together with procurement savings through increased buying power, could result in $60m of cost synergies.
A further $40m of benefits could come from better online booking services and advertising income.
Half of its customers in the UK pre-book tickets online, incurring a £1 booking fee. In the US, only 20% of Regal’s customers book online, and most of these are via a third party which takes most of the $1.50 booking fee.
Berenberg says Cineworld will soon start to allow Regal customers to book their own seats online. Its analysts believe this move could help achieve $30m of incremental booking fee revenue should it drive online transactions back to cinema operator’s website and the proportion of pre-booked tickets increases to 30%.
Other potential ways to help drive earnings is to roll out Cineworld’s Unlimited membership scheme in the US where customers can see as many films as they like per month for a set fee, providing revenue visibility and helping to drive up food and drink sales.
After a terrible period in 2017 for film releases, 2018 is looking much healthier which bodes well for Cineworld and its enlarged cinema estate.
We’ve already seen Black Panther overtake the latest Star Wars film with $1.33bn at the box office since its release in February. Avengers: Infinity War made history last month with an estimated $630m worldwide taking on its opening weekend.
Later this year will see the latest instalments of various blockbuster franchises including Incredibles, Mission Impossible, Solo (a Star Wars spin-off), Jurassic World, Fantastic Beasts and a sequel to Mary Poppins.
A trading update is due on 18 May where Cineworld faces tough comparative figures. The real test for the share price though will be management proving they can execute plans in the US.