SeaWorld (NYSE:SEAS) remains poised to decrease in value, investors should consider it a potential short candidate.
SeaWorld Entertainment is a theme parks and entertainment company which operates 11 theme parks in the United States. The company split from its parent company Blackstone Group in 2012 when it had its initial IPO valuing it at $2.5 billion. Blackstone still owns just over 20% of the company, but their interest has likely faded as they already made a gain of over 170% by taking value out of the company. Investors should follow Blackstone's lead, in which they have been decreasing their stake in the company because SeaWorld Entertainment will likely continue to see its stock price decline over the next few months. Based on current estimates, SeaWorld will have its second straight year of declining revenues and declining profit, and its third straight year of declining park attendance. But actual performance into the future may be much worse than analysts and company guidance suggest.
Poor Debt Management
SeaWorld's poor debt management in itself should be a serious enough issue to short the company. Total liabilities continue to increase, which threatens SeaWorld's ability to borrow. Debt to equity has been steadily rising, to the point where it now exceeds 100%.
Rising rates will exacerbate this problem, as SeaWorld has about 25% exposure to floating rate debt, and its 75% exposure to fixed rate debt (through rate swaps) is only available through September 2016. This does not provide much of a hedge as it is unlikely rates will rise significantly by that time, and furthermore, once SeaWorld is again in talks for a rate swap, the rates SeaWorld faces will be much higher than previously contracted. SeaWorld's long-term debt is rated as B1 by Moody's and BB- from S&P, which both reflect junk status and render it difficult for the company to borrow money.
Liquidity Remains Threatened
With this poor debt management comes poor liquidity, which is extremely important for theme park operators for maintenance purposes. SeaWorld's liquidity metrics should trouble investors, as it shows SeaWorld has very little room for dividend payment increases or any other unforeseen cash payments (which include maintenance, fines, and lawsuits). With negative net working capital, SeaWorld is very vulnerable to these risks.
(Note: The data for Six Flags reflects 2nd quarter statistics, not the most recent 3rd quarter results. This ensures an apples-to-apples comparison)
Not only is SeaWorld's liquidity in a poor position, but it has actually been worsening during a time when similar firms in the industry have been able to maintain their liquidity metrics. From year end 2014, SeaWorld's current ratio is down more than 11% from .643, whereas Six Flag's current ratio is up about .5% from 1.299. Thus, it would appear that SeaWorld is lagging industry performance and that diminishing liquidity is something investors should be concerned about, especially because SeaWorld does not have many reserves to draw from. With junk status on SeaWorld's debt, raising funds through notes remains extremely expensive. SeaWorld's most reliable option is through their revolving credit of $192.5, which is good through April 2018 at a variable rate of L+250. However, with SeaWorld's weakening liquidity, this credit could dry up much more quickly than anticipated, and SeaWorld could see this credit line get reduced and be hit with more stringent debt covenants, if not evaporated completely come April 2018 due to their downgraded credit ratings.
Looming dividend cut
This poor debt and liquidity not only threatens day to day operations, but threatens the dividend as well, which management seems to be paying only to keep the stock from entering a free fall. The current payout ratio of over 300% is representative of declining profit, and a payout ratio that has been rising the past few years.
To pay this expensive dividend, SeaWorld must continue to take from working capital and capital expenditures. This will backfire at some point, and smart investors will get out of the stock before it's too late, as Blackstone has been doing. In the theme park industry, there is always the potential for an accident that could close a park down permanently. Additionally, there will always be unexpected expenses which must be paid, whether it be unforeseen maintenance or fines levied by regulators.
This dividend will be cut, it's just a matter of timing the exit so that large shareholders can get out. It is naive for investors to believe that the dividend is safe because it has a solid history.
Increasing Oil Prices Will Hurt Park Attendance
Besides the poor balance sheet, macroeconomic and other external pressures also do not bode well for SeaWorld. SeaWorld is very reliant on tourists having disposable income and a desire to visit its parks. To be profitable, SeaWorld must do two things: Get consumers inside their parks, then get consumers to spend their money while inside.
Source: SeaWorld Investor Relations
The much more important part of the equation is admissions, not just because 62% of revenue is derived from it, but because it is the highest margin portion of the business. There is virtually no variable cost involved in admissions, so the higher attendance in the park, the higher the profit. Disposable income for consumers directly correlates to the amount of time and amount of money consumers spend on vacations, and SeaWorld parks are a big beneficiary of decreased oil prices. This is not just because consumers have more to spend, but also because travel is much cheaper, both for consumers making the drive by car (SeaWorld likes to brag that there are 50 million people within 150 miles of its parks) and by plane.
However, in the same breath, it must be mentioned that SeaWorld faces significant risk should oil prices rise. Disposable income decreases as gas prices rise, and even more importantly, airplane tickets' costs rise as oil increases, even with hedging in the airline industry. Increasing plane tickets makes the trip to SeaWorld resorts more expensive for consumers, and encourages more local travel for family vacations. SeaWorld has seen declining park attendance for the past two years (plane ticket prices during this time have been essentially flat), and a rise in US Domestic Airfare will see this trend continue.
Should oil prices rise further, consumers will see a decline in disposable income and see transportation costs rise, including the price of plane tickets.
Oil is expected to gain over the coming months, mainly due to the fact that a majority of oil production in a production site comes during the first year of operation. This past year, while oil prices have remained low, companies spent much less on capital expenditures and new production facilities, as the low prices made it uneconomical for many firms to continue to spend money to increase production.
The marginal benefit of additional oil production was so low that many production sites shut down completely. This will be reflected in the coming months as the supply of oil in the market decreases causing a rise in crude prices, as has already been occurring this past quarter.
The decline in production is still occurring, as prices have been remarkably low for some 9 months or so. This decline in the quantity of oil supplied will lead to increased oil prices, which will lead to an increase in the cost of fuel, which will be passed along to consumers in the form of increased airline tickets. None of this bodes well for SeaWorld.
Bad Press and Animal Cruelty Will Continue to Hurt Park Attendance
After the release of the film Blackfish, SeaWorld faced an immense storm of negative PR. Blackfish purported to show the alleged abuse of orcas at SeaWorld, and essentially blamed the company for the deaths of trainers in previous years. This film played right into the growing trend of social awareness surrounding animal abuse, and caused a perfect storm of controversy for SeaWorld. The effect has been obvious. Attendance this year will be down for the third straight year, and this shows no signs of stopping despite SeaWorld's best efforts to turn their image around. SeaWorld drew criticism for going so far as to even stuff ballot boxes on online polls about the company, and the media and journalists continue to persuade the public against visiting the parks. There are entire websites created by "socially conscious" groups designed to take down SeaWorld. Needless to say, this campaign against SeaWorld has worked. SeaWorld has left the public's favor and current animal rights trends seem to show that the company will not find its way back, as polls continue to show an increasing number of Americans disagree with keeping orcas in captivity.
Regulators Will Continue to Give SeaWorld Trouble
As usually occurs when a company leaves the public's favor, the government tries to step in and help the decline, instead of letting the free market do its job. Regardless, regulators have not been kind to SeaWorld and show no signs of stopping.
Due to declining revenues and park attendance, SeaWorld recently announced plans to grow customer interest in their parks through the Blue Ocean Project and to invest in larger orca tanks in an effort to enhance the guest experience (not to mention the positive PR they hope it generates). The California Coastal Commission approved these plans, but banned SeaWorld from breeding orcas in captivity, a move which is garnering praise from the pro-animal and the anti-captivity crowd, and which passed the commission by unanimous vote. This decision led to a stock price dip in SeaWorld after the announcement October 9th, which has since more than recovered due to investor hopes that SeaWorld wins the lawsuit.
Even if SeaWorld is able to win its lawsuit against California, regulators will continue to bother SeaWorld. SeaWorld's business model is not conducive to the growing concern about animal treatment, despite SeaWorld's efforts to present itself as saving animals. Regulators have been trying to crack down on SeaWorld for the past few years, and eventually they will be successful in diminishing SeaWorld's bottom line. Here are just a few of the hassles from regulators in recent years:
February 2014: USDA Cites SeaWorld For Animal Abuse
March 2014: California tries to ban Orca shows
April 2014: Court Refuses to Allow Trainers to Swim With Animals
June 2014: Congress Grants Funding for Studies on Orca Captivity
April 2015: Regulators Fine SeaWorld For Worker Safety
October 2015: California Bans Orca Breeding in Captivity
It seems no matter how hard SeaWorld fights back, regulators will still find a way to hurt a company and industry that they do not find agreeable.
Rising Labor Costs from Minimum Wage Hikes Will Increase Expenses and Further Hurt Liquidity
Minimum wage hikes are sweeping the country, and SeaWorld will see its expenses increase because of this. Besides the increasingly likely potential for a national increase in the minimum wage to $10.10, California is home to many pockets of higher labor costs.
Already, San Diego has approved a minimum wage hike to $11.50 an hour by 2017. The average hourly rate for ride operators at SeaWorld is $9.66, according to glassdoor, and an increase to $11.50 represents $1.84 per hour premium. There is also the threat of rising wages in the rest of the US as well. With the increasingly highly regulated nature of SeaWorld's business, it seems unlikely that SeaWorld will be able to recoup most of these expenses by cutting hours, and furthermore, building positive PR can rarely occur with worker layoffs. This increase in expenses will directly affect SeaWorld's bottom line, and shift more of SeaWorld's expenses to current liabilities. Wages are usually paid biweekly, and this 14 day payable is much less than SeaWorld's current 41.77 days payable outstanding. These increased wage expenses will weight the days payable downwards, hurting liquidity and elongating the cash conversion cycle.
Days payable outstanding can be an indicator of financial stability for a company, and it's been remarkably accurate in assessing SeaWorld's stock price.
SeaWorld's unfavorable movements in DPO are reflected by the decrease in share price. Should wages increase, this would accelerate SeaWorld's decline in DPO, resulting in worsened liquidity and in turn, a weakened share price.
Weak International Tourism Will Continue
Not only does SeaWorld operate in a very cyclical industry for the American public, which is highly dependent on the disposable income of American consumers, but SeaWorld also relies on foreign tourism to its parks as well.
Source: SeaWorld Investor Relations
Foreign tourism represented 16% of revenues is 2014, but that percentage is likely to decline going forward. A strong US dollar makes it more expensive for tourists abroad to visit the US, and it makes other locations comparatively cheaper. The dollar is likely to continue to gain, as it has the past 5 years:
The US dollar is likely to continue to gain strength into the future, as central banks around the world continue their monetary stimulus while the US Federal Reserve borders on raising rates, and will likely do so sometime in the near future if we heed the words of chairman Janet Yellen. An interest rate hike would push the dollar's strength upwards, and the cumulative effects of dovish policies at foreign central banks will weaken currencies in relation to the dollar.
Geographic Locations Show Minimal Growth Potential
SeaWorld owns 11 parks throughout the United States, however, the geographic locations of the 11 parks are not so spread out and present in only 5 states. Management contends that this allows it to have monopolies in the metropolitan areas that they focus in, but this also leaves SeaWorld highly sensitive to changes in state policies.
Source: SeaWorld Investor Relations
Of the five states where SeaWorld operates, a majority of revenue comes from Florida, which demonstrates SeaWorld's high sensitivity to Florida's political and economic environment, and remains especially prone to tax rate increases in the sunshine state.
Source: SeaWorld Investor Relations
The likelihood of rising taxes in Florida is becoming more of a certainly as time goes on. Democrats are much more likely to vote to raise taxes, and democrats seem to have an advantage in Florida going forward. Demographic observations of Florida votes shows that non white colored voters have increased their portion of the electorate to 38% from 35% in 2012, and this trend shows no sign of slowing. Blacks and Hispanics not only overwhelming vote democratic, but the rate at which they have been voting democratic has also been increasing.
Besides the sensitivity to Florida, SeaWorld also derives about 1/5 of revenues from California. California's economic growth has been largely driven by the tech sector, with most other segments of the economy hurting during that time due to California's regulation and tax heavy environment. Should tech IPOs frequency and performance decline, California's economy could do the same. There is evidence that tech IPOs will falter going forward, as the past few months have shown poor performance by many recent IPOs. Long term, this does not benefit SeaWorld as property taxes will need to be raised to close budget shortfalls.
With a price to earnings of over 70, and a forward rate of over 25, SeaWorld is highly overvalued and there is little room to the upside. The downside risk, on the other hand, is immense. Like all theme parks, SeaWorld is always one incident away from a potential hit to consumers' notions about the company, and one incident away from a potentially large lawsuit which could wreak havoc on SeaWorld's already weak balance sheet. The only downside protection for SeaWorld comes in the form of its 2,000 acres and real estate holdings, except even this is subject to huge risk. With these real estate holdings, taxes still need to paid, and the only income from real estate can come in the form of rent. The more than likely scenario is that debtors take the real estate holdings before shareholders see anything, as it is more than likely that SeaWorld has been using its real estate as collateral for its credit, especially because of their increasingly poor liquidity and credit rating. SeaWorld might be better managed as a REIT which leases its real estate out to independent park operators. But that is irrelevant for current shareholders, as any restructuring of the company would most likely leave common stock holders with nothing.
Blackstone Group has already taken their profits from the company, and are continuing to do so. Expect SeaWorld to depreciate in price going forward, with a potential catalyst being an imminent dividend cut.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.