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I recommend purchase of Marcus Corp (NYSE:MCS).
Investment Thesis
A weak box office industry-wide and disappointing recent results in Marcus' theatre division have brought the stock close to tangible equity of $10.10 a share. MCS, which has only traded below book value for a brief period in early 2009, could reach my target price of $14 by proving the setback in theatre profits is temporary. The company's solid record for withstanding past downturns in theatres, its largest profit generator, suggests the company will be able to take advantage of what looks to be a strong slate of films in 2011. Meantime, continued momentum at hotels and resorts should ensure low-double digit operating profit growth in FY 12 (May '12).
Since it became clear that the industry-wide box-office would suffer a dramatic drop, the stock has fallen some 25%. Thus, signs of a normalization in the usually steady theatre division is necessary to lift MCS from its recent malaise. Difficult comparisons from Alice in Wonderland in the comparative period suggest that investors only need a sequential improvement to prove FQ3 (Feb.) results were an aberration. Premium-priced 3D films and reliable sequels throughout 2011 should provide a year over year lift to box office results for FY 12.
2008
2009
2010
2011E
2012E
EBITDA
79.0
75.7
71.1
71.0
77.8
Capex, theatre purchases
(64.9)
(34.3)
(24.3)
(30.0)
(30.0)
Income tax paid
4.4
3.3
(7.6)
(7.6)
(9.3)
Interest expense
(13.6)
(16.0)
(11.0)
(10.2)
(9.5)
Free cash flow
4.9
28.7
28.2
23.2
29.0
Dividends paid
(9.9)
(9.8)
(9.9)
(9.7)
(9.5)
Share repurchases
(14.2)
(0.1)
(0.5)
(10.0)
(6.0)
(Increase)/decrease net debt
(19.3)
18.7
17.9
3.3
13.2
Share Buybacks Accelerate
As the table above indicates, Marcus generates significant free cash flows. The debt arising from the purchase of 83 screens in 2008 has essentially been paid off, putting debt to total capitalization below 40% today. Last spring, the company began stepping up its share repurchase program, and during the first half of FY 2011 (May ’11) spent another $4 million buying back its own stock, at an average price of around $10.80, above recent quotations. My cash allocation forecast above assumes the company buys back another million shares through FY 2012.
Property Ownership
The company owns 44 of the 54 theatres it operates, and seven of its 18 hotels and resorts. While property divestitures or sales and lease-backs are de rigueur, MCS' notable property ownership would be more appreciated by investors as property values improve and commercial rents increase. Unlikely to be monetized, the company’s solid real asset backing – which generates a return above its <6% pretax interest cost – lends further support to book value.
Theatres
2007
2008
2009
2010
2011E
2012E
Box office revenues
98.2
114.7
137.3
142.7
131.3
133.9
Concession revenues
49.0
56.9
67.9
67.8
61.0
62.9
Other revenues
9.3
9.5
10.1
13.6
12.9
13.4
Total theatre revenues
156.5
181.1
215.3
224.1
205.2
210.2
Operating income
34.6
35.3
43.7
44.7
38.9
40.6
Theatre EBIT margin
22.1%
19.5%
20.3%
19.9%
18.9%
19.3%
Comparable attendance (% chg)
-1.7%
-2.1%
0.1%
-3.0%
-10.0%
-2.0%
Average ticket price
0.2%
4.9%
5.4%
7.7%
2.5%
4.0%
Concession sales (pp)
2.4%
5.2%
4.2%
3.6%
2.0%
3.0%
Steady migration to film-viewing through other channels (e.g., VOD, DVD rental) along with volatile consumer spending have constantly challenged the theatre industry. However, continued declines in attendance -- by myriad in-home options -- have nearly always been offset by higher ticket prices, new ancillary services and increases in per person concession sales, as the table above shows. Moreover, a customer base that is relatively insensitive to nominal price increases has helped MCS' theatres grow profits in six of the past eight recessions.
I assume MCS will continue to raise admission prices -- with only modest declines in attendance -- helped by an increase in premium product, namely a growing slate of 3D movies. A schedule of 30 movies in 3D set for release in 2011 should help these higher-priced films account for almost a quarter of MCS’ admissions revenues over the next year. Further consolidation of this mature industry should also contribute to favorable pricing. As one example, Regal Cinemas (NYSE:RGC), the largest theatre chain, plans for net screen closings in 2011.
Strength at Hotels & Resorts Overlooked
RevPAR at MCS’ hotels will likely finish 15% higher in FY 11, driven primarily by higher occupancy levels. Room rates have only recently begun to trend upward. The 3% rise in room rates during the February quarter is likely to be followed by higher rates going into the critical summer months, supported by occupancy levels that are approaching the most recent peak. My FY 12 estimated operating profit increase of 20% for the hotels unit assumes RevPAR of 9%, with about a 50/50 split between occupancy and rate increases.
Theatres:
2008
2009
2010
2011E
2012E
Operating income
35.3
43.7
44.7
38.9
40.6
Depreciation & Amortization
15.1
16.4
16.7
16.9
17.0
EBITDA
50.4
60.1
61.4
55.7
57.6
Hotels:
Operating income
21.6
9.7
1.4
9.4
11.3
Depreciation & Amortization
15.5
15.2
15.0
15.0
15.0
EBITDA
37.1
24.9
16.4
24.4
26.3
In their concern for the theatre business, investors have overlooked this turnaround underway at Marcus' hotel operations. My forecasts in the table above suggest that a $8 million increase in more highly valued hotel operating income in the current year exceeds the less than $6 million decline in theatre segment profits.
Marcus has grown food and beverage profitability during this early stage of the current lodging up-cycle, whereas most other hotel operators have seen their food and beverage results languish despite higher RevPAR. (Guests industry-wide are paying more for their rooms, but moderating spending after checking in.) Meanwhile, guests at Marcus' hotels are increasing their F&B consumption at a rate comparable to occupancy gains, and margins from F&B are expanding widely.
Valuation
I value MCS at slightly less than 9x my FY 12 EBITDA estimate of $78 million, resulting in a target price of $14 a share. I also use a sum-of-parts valuation. In the SOP, I ascribe 5.5x and 14x multiples to next fiscal year’s forecasted EBITDA estimates for the theatre and hotels divisions, respectively. After applying a 9x multiple to central overheads and netting debt, I arrive at this same $14 target for the stock.
Main Risk to Investment Thesis
Certain studios (e.g., Time Warner (NYSE:TWX)) and distribution partners (e.g., DirecTV (NASDAQ:DTV)) are testing the idea of shortening the window for video-on-demand (VOD) release, from the standard 130 days to as few as six weeks. Calling it premium VOD, and charging up to $60 for a film, the intent is to offset lost DVD sales. Theatre chains are vigorously fighting a potential change in the business model, where the theatres themselves account for the largest piece of a studio’s revenue stream. Depending on the success of this new service, studios might then use premium VOD as leverage to increase the studio's film split, from past levels of about 50-50.
Business Summary
Marcus Corp is a Milwuakee-based operator of theatres and hotels. Its 684 screens make it the sixth-largest theatre operator in the US. The 18 hotels and resorts owned or managed by Marcus are located in nine mostly Midwestern states. Controlled by the Marcus family, the company is conservatively managed, with low debt ratios (despite significant property ownership) and a high dividend yield (>3%).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: Buy Marcus Corp. Near Book Value