IMAX: Where's the Love?

| About: IMAX Corporation (IMAX)
Shares of entertainment technology firm IMAX (NYSE:IMAX) are trading for half what they were changing hands for three months ago. Although Q2 2011 results were well-below Street and consensus estimates, the Merriam Report dual cash-flow and accrual model indicates IMAX shares may be significantly oversold at current levels.
IMAX operates in a niche entertainment market providing large format film presentations and motion picture technologies.
There is a certain irony when the stock price of DVD and streaming content provider Netflix (NASDAQ:NFLX) blasts to the moon while a nuts and bolts entertainment platform provider such as IMAX gets sent to the woodshed.
IMAX and NFLX have very different business models and comparing their respective financial statements would be apples-to-oranges. But, with NFLX selling at 41 times book, 200 times cash-flow and 65 times earnings, investors might want to consider the virtues of hammered-down IMAX shares.
What analysts are missing: Much of the analyst views we see are too focused on backlog and installation rates rather than how the company is managing its liquidity and resources as it grows. We believe the sell-off in IMAX shares offer compelling opportunity based on earnings quality and cash-flow.
While Apple (NASDAQ:AAPL) might well be the mother of all exceptions to any investing rule, the nascent but explosive growth in streaming content is also distracting investors away from infrastructure plays such as IMAX. More important, we also believe that investor’s under-estimate IMAX’s growing global presence.
Cash-Flow: IMAX earnings have historically been supported largely by the effects of balance sheet maneuvers rather than pure operational cash-flows. Yet, in recent quarters the gap between OCF and balance-sheet cash has narrowed dramatically.
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In particular, our dual cash indicators also indicate that despite the capital intensity and deferred nature of the financing and joint-venture arrangements involved, the company is none the worse for wear financially.
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Accruals: We do note a bearish trend in the use of accrual accounting techniques during the past few quarters. However, the Q2 ratio of +7.96 is reasonable when compared with the average +5.68 generated in the seven previous periods.
Capital Productivity and Revenue Metrics: The bigger knock we see is margin challenges, with cost-of-sales and accounts payable the primary culprits. Payables grew 37.3% in the latest period compared to the average 12.2% in the prior seven quarters.
The cost of asset returns (per $ of sales) also spiked in the recent Q2. We note deterioration in inventory, accounts receivable and P/P/E as compared to the average of all periods reviewed.
Keep in mind that finance receivables account for a bulk of IMAX’s total accounts receivable. While the 196 day DSO (days-sales-outstanding) posted in the recent quarter appears excessive, investors are encouraged to observe IMAX’s collection cycles in a broader context (rather than exclusive to “trade” receivables).
Put another way; keep an eye on the cost of receivables to sales. Q2 receivables-to-sales cost IMAX approx. $2.16 for each dollar of sales it generated. The average receivables/sales for the prior seven quarters was only $1.87.
Another asset-return to watch is P/P/E to sales. For lack of a better term, “capacity” costs in Q2 for IMAX were $1.55 (per buck of revs) vs. an average $1.18 in the previous periods.
Intangibles: One of the more positive trends developing can be seen in goodwill as a percentage of both equity and assets. In each of the past three quarters, goodwill has been incrementally declining as compared with the average of our review period. This tells us that at the present time, the potential for impairment risk is minimal.
Summary: Our model pegs estimated fair value for IMAX at $30.55 per share. At current prices, the stock looks to be undervalued by -42.6% to our FV estimate.
There are risks to consider. The stock has been under significant distribution since June. As of July 15, 11% of float has been held short and insiders have been unloading shares in the past few months. Beta is 2.17 and twice as volatile as the S&P 500.
Consumer spending is also showing signs of weakness. We find it surprising that consumer discretionary stocks (retail apparel, coffee/beverage and the like) are being rewarded with multiples last seen in the tech sector prior to the bust. Entertainment stocks too, are also very discretionary.
Yet, ever since Thomas Edison rolled out Vitascope Projectors back in 1896, going to the “picture show” has been a staple of modern culture. Granted, streaming content is changing the landscape for how we view films and media, but we suspect folks will always be up for viewing the next blockbuster when it is released and in bold IMAX big-screen fashion.
Short-term traders might find sufficient opportunity at current levels. Longer-term investors may want to consider initial positions near the $17 area; full positions up to $15. Or, for the digital media-stock junky, take some profits on the richly valued NFLX and take a shot with IMAX.
Disclosure: I am long IMAX.