By The Valuentum Team
Cedar Fair (NYSE:FUN) is one of the largest regional amusement-resort operators in the world, which is a relatively healthy, stable industry. It benefits from significant barriers to entry keeping in-market competition limited and that there is no truly comparable at-home experience, even though any form of entertainment can be viewed as competition. Recent performance has been strong--2015 marked the sixth consecutive year of record results in terms of total revenue and adjusted EBITDA. The company has literal room for growth as there is more than 1,300 acres of undeveloped land adjacent to its parks, which it plans to use for accommodation services for guests, youth sports facilities, and/or complementary commercial development.
As an master limited partnership, Cedar Fair's dividend health is dependent on access to the capital markets, which we do not like at all. Though we expect such access to remain sufficient in the near term, investors must be cognizant of the current dynamics at play that have suppressed the cost of raising capital in today's markets. If, or when, this is no longer the case, the MLP's distribution could be in jeopardy, as was the case during the Financial Crisis. Its yield has grown to more than 5.6%.
Management plans to grow future distributions at least in line with the growth of the business, but this of course is arbitrary and dependent on its ability to pull in new capital (it can't handle both its growth initiatives and distribution payments without market assistance). Competing capital allocation options have the potential to impact the pace of future distribution expansion as well, as investment in growth is a top priority, and the company's material debt position should not be taken lightly. We think Cedar Fair's unadjusted Dividend Cushion ratio is the most appropriate measure of the riskiness of the payout, even though its adjusted Dividend Cushion ratio is not stellar.
It's easy to get excited about the dividend yield, and that's fine, but investors should be cognizant of the financial risks, which have already come home to boost many MLPs during the past 12-18 months.
Cedar Fair's Investment Considerations
• Cedar Fair is one of the largest regional amusement-resort operators in the world, and it operates as a master limited partnership. The MLP competes for discretionary spending with all phases of the recreation industry, including several destination and regional amusement parks. The company estimates that it entertains ~24 million guests annually. It was founded in 1983 and is headquartered in Ohio.
• Cedar Fair operates in a healthy, stable industry. Significant barriers to entry keep in-market competition limited, there is no comparable at-home experience, and its cash-flow profile is generally recession-resilient.
• At last count, the firm had 11 amusement parks and entertains more than 20 million guests annually. It holds three separately-gated outdoor water parks, 1 indoor waterpark, 5 hotels (~1,700 rooms), 5 campgrounds, and 2 marinas in its portfolio. We think its facilities are world-class, and management is quick to highlight this opinion as well. Nine out of 10 guests are repeat visitors.
• Though the company is making strides to reduce its consolidated leverage ratio, total debt stood at ~$1.56 billion at the end of the third quarter of 2015, significantly higher than its cash balance of ~$196 million. Cedar Fair's hefty annualized distribution will keep a tight lid on its cash reserves and financial flexibility.
• Cedar Fair is targeting $500 million in adjusted EBITDA by 2018 in its FUNforward 2.0 growth plan, the drivers of which include encouraging advance purchase commitments, new digital technology opportunities, prudent capital management, and complementary development adjacent to its parks.
Economic Profit Analysis
In our opinion, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital.
The gap or difference between ROIC and WACC is called the firm's economic profit spread. Cedar Fair's 3-year historical return on invested capital (without goodwill) is 22.7%, which is above the estimate of its cost of capital of 9.2%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT.
In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Cedar Fair's free cash flow margin has averaged about 15.4% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG.
The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Cedar Fair, cash flow from operations increased about 5% from levels registered two years ago, while capital expenditures expanded about 46% over the same time period.
We think Cedar Fair is worth $52 per share with a fair value range of $39-$65.
The margin of safety around our fair value estimate is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 3.7% during the next five years, a pace that is lower than the firm's 3- year historical compound annual growth rate of 5%.
Our model reflects a 5-year projected average operating margin of 25.6%, which is above Cedar Fair's trailing 3- year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2% for the next 15 years and 3% in perpetuity. For Cedar Fair, we use a 9.2% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $52 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph above, we show this probable range of fair values for Cedar Fair. We think the firm is attractive below $39 per share (the green line), but quite expensive above $65 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Cedar Fair's fair value at this point in time to be about $52 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Cedar Fair's expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $60 per share in Year 3 represents our existing fair value per share of $52 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.