Regal Entertainment Group (RGC) looks fairly compelling on the surface for the average investor: a 6% dividend yield, a 1 year mean analyst target price of $16.67 that represents 21% price upside from its current value, and a technical up trend. In this article, we'll take a look at some of the underlying issues of Regal and whether the in-depth look agrees with the surface assessment.
As seen above, Regal's revenue 5 year growth rate ('07-'11) is 0.79%. One could make the argument that as the movie theatre experience is a discretionary purchase; this number is fairly impressive given the difficult financial status of today's US consumer. Revenue mix has been fairly consistent over this time period, too, with 70% of revenue coming from admissions and the remainder coming from concessions. A key shift has taken place in the industry, especially over the past few years. A premium experience is being sold by the movie theatre industry with a significant price increase to the ticket price. 3-D tickets run a premium of $3.00 -$4.50 per ticket, RPX (Regal's own IMAX like experience) a premium of $5.00 - $6.00, and IMAX (IMAX) a premium of $5.00 - $7.00. According to Regal CFO David Ownby in the most recent earnings conference call, the average ticket price for the Second Quarter of 2012 was $15.81 for IMAX, $12.11 for 3D, and $8.41 for traditional 2D. In 2011, 19% of the total domestic box office sales was from 3D and IMAX ticket.
Now with this knowledge, lets put the revenue number back into perspective. While I was unable to find the listed ticket sales per year for Regal, we do know that the premium experience for movie goers is now a significant part of the above revenue number. Due to the flat nature of revenue, a not so far fetched assumption is that the number of tickets sold would be declining. This is not a good trend for movie theatres as it points out that customers are simply not going to the movies like they were. Additionally, Regal and other theatres are dependent on the strength of the overall yearly movie lineup they are playing for the year, but especially the summer. For 2012, major blockbusters have carried the bulk of the year with titles such as The Avengers, The Hunger Games, The Amazing Spiderman, The Dark Knight Rises, Brave, and Ted. The remainder of the year should prove to be strong with the final Twilight installment, James Bond: Skyfall, The Hobbit and Life of Pi.
By looking forward and assessing the strength of the 2013 movie lineup, a worry from movie theatres may be the general absence of highly anticipated franchises in 2013. Movie studios seem to be anticipating this with re-releases of older blockbuster movies in 3-D or IMAX technology (Star Wars, Jurassic Park, and The Little Mermaid). The counter argument is that the lack of blockbusters don't necessarily break the revenue number, but there is more of a reliance on the potential unknown movies that become popular and a must-see. While this does happen frequently, it makes forecasting difficult how many of these dark horse movies become successful for the industry, and also for the theatre.
Regal Entertainment Group consistently has to play catch up in regards to Property, Plant & Equipment maintenance and continually invest in the latest technology to keep providing customers the best theatre experience. Regal's goal is to build 100 screens per year, buy 200 screens per year and retire 200 screens per year. The company has generally done this by retiring old theatres with fewer screens and building geographically better theatres with more screens (9-10). Regal has also had to upgrade their film projectors to be 100% digital (this should be completed by the end of year), and invest in technology such as 3D and IMAX. This has averaged $100 million / year to accomplish this strategy and will continue to stay ahead of industry trends. Other costs are variable (mostly human resource costs) and follow the particular demand of each movie release.
Capital Structure Issues
When analyzing the balance sheet of Regal, what really pops out to the eye is the level of debt. The 2011 Interest Expense for the company was $149,700,000 while the total Long-Term Debt was $1,936,100,000. Doing the division, the average interest rate paid in 2011 was 7.73%. This is problematic to say the least. With cash on the balance sheet at $253 million, there isn't a lot of financial flexibility for the company at the present time. As you can see below, with no maturities coming due until 2017, the company has no ability to retire the high yielding debt and reissue at more appealing rates.
Management should also be looking to the future for when the debt matures. With a current credit rating of B1/B+, management should be very focused over the next 3-5 years of improving retained earnings and cash balances on the balance sheet. By doing so, Regal's credit rating would improve and lower their overall cost of capital when its time to reissue debt.
However, management and analysts seem primarily concerned about the level of dividends being payed to shareholders. Looking at the chart below, management seems to be following more of a hybrid residual dividend policy and is stripping much of cash from the balance sheet in order to pay these dividends. Note that last year's and this year's dividends are to be $0.84/share while net income last year was $0.33/share and this year is anticipated to be between $0.74 -$1.01.
Of worry for the company is the narrow financial moat that they have by following these policies. If earnings do not outpace dividends as anticipated, Regal could easily find themselves in a situation to have to cut their dividends to shareholders. This in turn would punish the share price of the stock.
After getting much more familiar with Regal, I would be more apt to use the low end of the analyst range for 2013 EPS of $0.77. Then using an average 5 year P/E of 19, this gives me a target value for the stock over the next year of $14.63. Based upon the inherent risks mentioned above and the current valuation, I would not recommend this stock at this time.