Carmike Cinemas, Inc. (NASDAQ:CKEC) has been a winner this year, with the stock up 68% year-to-date (it traded at $11.50 as of August 31 close), but has been melting in the summer sun of late, declining almost daily since hovering in the $15-plus range early summer when investors were anticipating the releases of the year's biggest films: Avengers, Spider-Man and Dark Knight.
Of course, it would be easy to say the summer meltdown was a classic case of "buy on the anticipation and sell on the news", but it was more than that this time. Investor anticipation turned to fear following the tragic terrorism in Colorado in July - which understandably made moviegoers cautious.
To make matters worse, Carmike received a circuit-wide bomb threat in August, which it quickly diffused (the threat, not the bomb; there was no bomb found), but my guess is consumer reticence to enter one of their theaters increased nonetheless. Furthermore, the Summer Olympics have historically been known to temporarily hurt box office grosses - which it appears to have again this year.
So why come back to Carmike now? I can think of five compelling reasons:
(1) A record fourth quarter ahead,
(2) A continuing turnaround and emerging growth story,
(3) A vastly improved balance sheet,
(4) An interesting "hidden asset" in Carmike's 20% stake in Screenvision, the #2 cinema advertising company in America, and
(5) An attractively low valuation relative to my earnings, EBITDA and free cash flow estimates
I will examine each point, but before I do, I want to note that, despite bullish comments by Carmike's management about the remainder of the summer when it held its Q2 conference call, the third quarter has underperformed expectations (box office is -3% through last week), largely due to the aforementioned issues.
Also, the bomb threat occurred after Carmike held its conference call, so it could not have foreseen the impact that might have on cinema traffic (and my guess is it has had a negative impact). So we are adopting the old barfly advice of "go ugly early and beat the rush", as I expect Q3 could come in below analyst expectations - but Q4 should be a huge positive surprise. With that caveat, here is the case for buying the stock now:
There are various ways to forecast quarterly box office. My favorite way is to listen to what actual movie buffs think by using the crowd-sourced data from the Hollywood Stock Exchange (www.hsx.com). HSX is an online game people play in which they trade movies like stocks wagering what the first four week's domestic gross of a film might be.
For instance, in early May, The Amazing Spider-Man was trading for $181 and The Dark Knight Rises for $379. Both peaked in early July (before the Colorado shootings) at $220 and $488, respectively and closed at $210 and $389, respectively. Taking all movie "stocks" on HSX and grossing the data up for the full run (remember HSX values are for the first 4 weeks of a release only which represents about 85% of a movie's full run) and aggregating the grosses the "market crowd" is projecting a monstrous Q4 box office of more than $3.0 billion, a potential increase of 28% versus a disappointing Q4 in 2011. The all-time record Q4 at the box office was in 2009 at $2.8 billion.
The big releases in Q4 are, of course ,The Hobbit ($324 on HSX), Twilight: Breaking Dawn 2 ($307) and Bond flick SkyFall ($160). Assuming Carmike's box office per screen increases in-line with the 28% HSX-based forecast, EPS would come in around $0.55/share, compared to current consensus of $0.18. It is notable, too, that Carmike's box office per screen has actually outperformed the industry box office through the first half of this year (14.5% vs. 9.3%). This has been due to strong execution by management to deliver an improved cinema experience - which has led to a rebound in Carmike attendance and ticket prices (see below).
Moderating expectations slightly from the HSX-based forecast to a comparable box office to 2009 (still a 17% increase versus last year), I estimate Carmike can generate EPS of $0.45 vs consensus of $0.18. This would overwhelm what I believe could be $0.10-$0.15 of risk to current analyst estimates for Q3 (due to the bomb scare, etc.) and lead to EPS for the year of $1.15 before one-time items versus a loss last year. In that scenario, EBITDA would be $92 million, an increase of 27% versus last year. I suggest it's time to buy in the anticipation of a massive "earnings beat" in Q4 this year.
The turnaround story is the long-term reason to own Carmike shares. When I was a research analyst at Montgomery Securities, I used to cover Carmike, as well as its competitors AMC (recently acquired by Wanda) and Regal Entertainment Group (NYSE:RGC). Carmike usually traded at a much lower multiple of EBITDA and for good reason. It was deplorably run.
My associate and I conducted secret shopping across the Southeast examining the physical plant of the theatres and evaluating the experience. Carmike was routinely the worst with unkempt restrooms, sticky cinema floors, decaying seats and poor service. It also offered far less choice with an average of only 5 or 6 screens per theater. It got away with this because it was the only cinema player in town, as the company focused on serving smaller markets (and still does).
We concluded that Carmike was vulnerable to a new entrant in the market introducing even just a modestly better experience and rarely recommended the stock. That was 15 years ago. Now, under current management, the circuit has been upgraded. The company's 233 theatres average 9.6 screens for a total of 2,245 (#4 in the U.S.), have been converted to digital and offer 3D on 750 screens and a big screen experience (called Big D) on 13 screens.
While I haven't had an opportunity to "secret shop" the circuit like I did in the late 1990s, management has clearly focused on upgrading the physical plant. (That being said, a review of some reviews on Yelp and Movietimes.com indicate a range of experiences, some good, some bad. Hopefully management is reading these too and addressing the bad experiences.)
As mentioned earlier, the company's theaters have outperformed the industry in the first half of 2012. I don't expect they will in Q3 due to the bomb scare, but that was uncontrollable bad luck which could have happened to any circuit, and it appears to have been dealt with quickly and effectively with the help of the FBI. Furthermore, concession revenue per patron has increased a healthy 8% this year to $3.74 (excludes Screenvision impact) and that is where the money is made in the cinema business because margins are 88%+.
The knock on the company in 2011 and a contributor to its stock's descent into single-digits was a high degree of debt. This has largely been addressed this year through an equity offering and high yield debt offering (due in 2019), which gives the company significantly more financial flexibility to grow and compete going forward. Cash stood at $86 million (almost $5/share) at Q2 end and debt was $210 million. I expect cash to exceed $100 million by year end, unless the company makes an acquisition or distribution of some kind.
Including capital leases, total debt to EBITDA has come down from 5.4x last year to 3.9x and net debt (reflecting the cash balances) stands at a very serviceable 2.9x. Management has indicated it is now focused on growing the circuit again through acquisitions and new theatres. (It has been treading water at around 2,200 screens for the past three years while getting its financial footing back.) It is difficult to predict what acquisitions might be ahead and whether they are accretive, so we'll have to evaluate them if and when they occur, but the platform for disciplined growth is set.
In 2010, as part of an acquisition and recapitalization of cinema advertising company Screenvision (#2 to National CineMedia), Carmike, as Screenvision's largest customer, negotiated a 20% equity stake in the company and a $30 million payment - which it used to reduce debt in 2011. We estimate Screenvision was valued at $205 million at the time of its acquisition - of which $125 million represented equity in which Carmike owns 20% (subject to certain adjustments regarding screens committed to advertising). This represents an implied "hidden asset" value of $24 million (about $1.40/share).
Given the growth in the U.S. cinema advertising business (the industry has enjoyed compound annual growth of 7% in the past five years, despite the recession) and the potential de-leveraging one could expect at Screenvision, Carmike's stake could represent an even larger asset upon a liquidity event (either IPO, recap or sale by private equity firm Shamrock).
Finally, while an attractive valuation alone does not make a stock go up, Carmike's shares represent a compelling valuation at a current price of $11.50 trading at just 4.7x my 2012 EBITDA estimate of $92 million, just 7x my free cash flow per share estimate of $1.60 and 10x my 2012 EPS estimate of $1.15. What does make a stock go up, in my experience, is beating expectations, and I expect Carmike to handily beat a consensus EPS estimate of $0.80 in 2012 due to my robust expectations on Q4.
The shares have been declining consistently very likely due to concerns about what impact the bomb scare had on Carmike's attendance in Q3, and those investor concerns are valid. As mentioned earlier the Q3 box office has been lackluster to date (-3%), but should see a rebound against easy comparisons in September to finish about flat with last year.
If Carmike's box office per screen is in-line with the industry in Q3, then the consensus estimate of $0.24 looks achievable. Assuming Carmike's box office is inordinately hurt by the bomb scare and underperforms the industry by 5%, then I estimate about $0.10 to $0.15 EPS risk to the quarter. This, of course, would be a big earnings miss, but it is due to temporary and uncontrollable issues. (A year from now, few will remember the bomb scare.)
These concerns should be quickly overwhelmed by anticipation of a record Q4 combined with the controllable and longer-lasting improvements management has been making to the company's balance sheet and its theatres. Based on my 2012 estimates, and assuming Carmike can trade like other movie circuits (Regal and Cinemark Holdings, Inc (NYSE:CNK) at 6x EBITDA and 15x earnings, the shares have another 40%-plus gain ahead to my target of $17 per share. Like I said before, go ugly early and beat the rush!
By the way, I am long shares in CKEC and thus am eating my own cooking here. I can't imagine taking anyone's advice on a stock where they weren't either long or short, but hey that's just my opinion.