It is certainly hard to bottom-fish with the market at all-time highs, but the cinema subsector is one of the few that might present an opportunity, given that the major publicly traded players — AMC Entertainment (AMC), Cinemark (CNK), and Regal Entertainment (NYSE:RGC-OLD) — trade near 52-week lows. In today’s market, the only industries trading down are those that are undergoing (or have the perception of) massive disruption, and the theatre business is one of them. We’re coming off several solid years of great box office performance in the United States (5.2% annual from 2014-2016), and expectations are much lower for the next several years. Still, equity pricing appears favorable, and I can see why investors might be willing to take the contrarian approach and take the long side. Given little opportunity for differentiation at a local level, which of these three makes the most compelling choice for investors that want exposure?
Business Overview, Industry Challenges
Regal Entertainment has the highest current dividend yield (4.56%), and is likely the company that interests retail investors the most as a result, so I’ve framed this research from the perspective of this truly is the best choice. The company operates 7,262 screens, the vast majority of which are located within the United States (handful in U.S. territories). Regal Entertainment controls 20% of the U.S. box office, and has the second largest domestic market share (trailing only rival AMC Entertainment). This is where investors come to the first investment decision: If you’re looking for a solely domestic play, Regal Entertainment is the way to go. AMC Entertainment has expanded into Europe via the Odeon acquisition, and CinemarK trumpets their Central/South American exposure as a means of growth. Keep in mind that both Latin American and European are expected to see higher levels of box office growth, which is going to see these segments post higher earnings. The United States remains the top market, particularly for higher-end theatre retrofits (more on that later) and generally higher concession sales. Roughly 50% of revenue at Regal comes from food and beverage and other non-admission revenue, compared to 36-40% at the competition. Expect this to be the norm, and don’t expect a move into Asia either; with AMC having an easy in to the Asian market via Chinese billionaire Dalian Wanda (holds voting control), Regal Entertainment has all been locked out of the global theatre market – for better or worse.
Every company in this space highlights the positives of the movie industry quite well. Over the decades, this has been an incredibly stable industry with consistent (if a touch low) growth and strong free cash flow generation. The movies, despite complaints from consumers on ticket and concession stand costs, remain one of the more affordable out-of-home entertainment options that families can find. Despite low box office estimates, the product slate for 2017 and 2018 appear strong, with plenty of widely anticipated releases on the docket. On a local theatre level, re-seating towards luxury recliners, adding more IMAX/RPX screens, and enhancing food/beverage options (particularly alcohol) has been an excellent driver of improved theatre-level economics. AMC started this trend, and had led the charge, with 38% of screens having undergone renovation as of Q2 2017; Regal is not far beyond with 30% of screens expected to be updated by year end. I think it is key to frame this in the perspective of the question that persists in this industry: Why go out to the movies when you can stay in and also have an enjoyable experience? While luxury seats and good drinks and food are certainly a welcome reprieve from cramped seating and hours-old popcorn, this comes at a cost – higher expenditures per visit for each patron on average. While movie-going has been relatively recession-resistant, moving up the luxury goods ladder is likely to expose these companies to larger drops in revenue in economically slow periods.
Further driving the challenge of investing here, differentiation is hard to come by in this space. Consumers make choices on theatres based primarily on convenience (location, timing of start of a film) and perception of quality (ticket price versus quality of the venue). All the major publicly-traded theatre stocks have the access to capital in order to get in on the luxury retrofit trend that has boosted underlying earnings. In my opinion, this is a stereotypical consolidation-driven industry at this point given the relatively low margins, so I would suspect that we’ll see further mergers and acquisitions, and as a result the share of screens controlled by major players increase.
How To Compare Operating Results
Given the lack of differentiation, the expectation is for these firms to have similar profiles. There are some caveats here, one of which being owning versus leasing of properties: AMC Entertainment owns 4.6% of its theatres, Regal 9.8%, Cinemark 12.1%. Lease expense is going to hit operating earnings (impacting operating margin), while owned properties (generally paid for by debt if not already paid off), hit below the operating income line through interest expense. As a result, the expectation should be that the higher the percentage of owned properties, the higher operating margins will be. This is a contributing reason why Cinemark has much higher reported trailing operating margin (14.68%) versus 11.09% at Regal and 5.57% at AMC. I see a lot of trumpeting of Cinemark as the best operator here due to reported margin (operating/EBITDA margin), but investors need to be careful there. In the same vein, higher ownership exposure instead of leases is generally viewed as a more risky approach; see what has occurred in the REIT space for companies that have heavy real estate exposure in free-standing assets like movie theatres over the past eighteen months.
The leverage shows the clear trade-offs between the investment options in this industry. AMC, post the Odeon and Carmike acquisitions, is now the most heavily levered of the big three at 5.5x net debt/EBITDA, but is also the cheapest based on trailing pro forma earnings: 7.9x EBITDA. Interestingly, the most asset heavy company (Cinemark) is the least levered, at just 2.3x net debt/EBITDA, while also being the most expensive (9.1x ttm EBITDA). Regal Entertainment strikes a healthy balance between leverage and safety, particularly given the security that comes with domestic market exposure.
If I had to choose one of these three, Regal remains my choice. The dividend yield is attractive, cash generation is strong, and the North American market appears to have a cleaner risk/reward profile, despite the potential for higher growth in overseas markets. While not a holding within my own portfolio, investors could certainly do much worse when it comes to picking up either one of these three in my opinion.
This article was written by
I have a decade of experience in both the investment advisory and investment banking spaces, with stints in portfolio management, residential mortgage-backed securities, derivatives, and internal audit at various firms. Today, I am a full-time investor and "independent analyst for hire" here on Seeking Alpha.
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.