How To Take Advantage Of An Attractive Growth Prospect In AMC Entertainment Holdings

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About: AMC Entertainment Holdings, Inc. (AMC), Includes: CNK
by: WCC Investments
Summary

2018 proved that the movie industry is here to stay by breaking attendance records.

AMC is sitting in the 88th percentile for dividend yield in the entertainment industry at 5.35%.

Looking into potential risks and analyzing industry competitors.

Outlined covered call strategy to receive some nice premiums that can act as a monthly paycheck.

Editor's note: Seeking Alpha is proud to welcome WCC Investments as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to the SA PRO archive. Click here to find out more »

AMC Entertainment Holdings (AMC) has had a rough few years despite a great 2018. AMC is not the only movie theater stock that has seen major declines that started back in 2015. The market began to adjust where they are putting their investments in the entertainment industry. Cord cutting seemed to be taking over. However, I think the movie theater industry is here to stay for at least a couple more years. Loyal fan bases do not have what it takes to resist viewing these upcoming movies (I will outline these movies later in the article) or pass up on some new very attractive subscription services that theaters like AMC is now offering.

I see AMC as the best prospect for my fixed income strategy because they are currently in a critical growth stage. We have seen a significant increase in capex spending which is a great sign that AMC is looking to expand and open more locations. Looking at AMC's financials, you can tell that AMC is taking on much more debt then its competitors, which is also a promising sign that they are looking to increase leverage and expand their revenues. While revenues are already much greater then their main competitor in Cinemark Holding Inc. (CNK), their gross margins are quite similar.

Take note that throughout this article I will compare AMC's situation relative to their main competitor, which is Cinemark. I believe that AMC is working hard to use their leverage and increased capital expenditures are signs that they will not only look to expand into new locations, but they will also look to decline their costs and improve their gross margins. I will explain how AMC's stock price compared to Cinemark's has seen major declines and why I believe you can take advantage of this newly created gap in the long run as I believe AMC's stock has room to run and catch up to its competitors during this growth year and great new content coming to the industry.

Source: The Numbers - Movie Market Summary 1995 to 2019. (Note: We are still mid-2019, so obviously ticket sales will look like they are declining.)

AMC had an excellent 2018. CEO Adam Aron outlined their performance in AMC theaters most recent Q4 2018 earnings report. He mentioned that the movie industry as a whole had a very successful 2018. Movies like "Black Panther," "Avengers: Infinity War," and "Incredibles 2" were some of the highlights. "Black Panther" reached 1 billion in earnings in just 26 days. Only 55 films since the year 2000 have surpassed 1 billion in earnings and it took them an average of 7 weeks to do that.

These record-breaking movies were a must for the movie industry, as the industry has been under scrutiny recently because of the fear that technology has become so advanced that it just isn't worth their time to spend $15+ to leave their home to go watch a movie. Well, AMC's record breaking attendance numbers for 2018 might be telling the bears to take a seat. Aron stated that 359 million people saw a movie at an AMC theater in 2018, which smashes their previous records. See the graph below for a more clear look.

Promising New Content

This is obviously great news, but can AMC keep this up? I am here to help you decide. An obvious major indicator of ticket sales is the quality of movies that were released that year and whether or not people wish to see that movie. Here is an outlook of movies that will/already have been released in 2019 that I think are worth getting excited about. A very successful movie that has already released in 2019 is "Marvel's Captain Marvel." The movie earned 455 million worldwide in its first weekend, and is currently on pace to become Marvel Cinematic Universe's most successful movie ever, although the movie will most likely hold the record for a very short period of time.

Yes, that's right, it beat "Black Panther," the tremendously successful MCU film that premiered in 2018. Other movies that I believe will make a crucial impact on the movie industry is "Avengers: End Game," which I believe will absolutely crush "Captain Marvel's" soon to be record. I believe this simply because Marvel contains one of the most loyal and vast fan bases in the world. These superheroes are people's idols. They truly believe that they are real in their hearts. Marvel has been premiering Avengers movies since July of 2008 when they premiered "Iron Man." The infamous Avengers tale has been keeping fans on hook ever since and it is all about to come to an end. Well this part of the story that is. The whole world wants to know: Will the Avengers defeat Thanos, are the people that vanished really gone forever, and most importantly, where will the Avengers story head next?

OK, enough of the movie nerd talk, and back to the finance nerd talk. Other movies that will look to be successful include "Aladdin" and "Toy Story 4." The original "Aladdin" that premiered in 1992 racked in 504.2 million in earnings. "Toy Story 3 (2010)" is one of those films that generated over 1 billion in earnings (1.067). Both of these franchises also have a vast fanbase.

The AMC Experience: Analyzing Risk

Unfortunately, there is only so much movie theaters can do to attract movie goers. Things like reward systems (AMC Stubs A-list), gourmet dine-in options, deals for students, cheap ticket Tuesday, and a great experience. Even if you do these things better than your competition, chances are if your target consumers closest movie theater is not an AMC, that it will not be worth it for them to make the extra effort to travel further. AMC has some very favorable locations in the heart of Hollywood, Chicago, and New York.

But that isn't why I like AMC so much. A big reason why I do like them is because of their unique experience. With a growing population of Millennials and Generation Z-ers, a convenient experience has seen a spike in demand. Things like movie theater bars, high end gourmet food, and exceptional service are good examples of these newly demanded luxuries. AMC can be considered a luxury movie theater compared to its competition in Regal Cinemas. Cinemark Holdings Inc and IMAX Corporation (IMAX) can be seen as close "luxury" competitors to AMC. The major problem with IMAX Corporation is their lack of content. They offer a revolutionary experience on these enormous screens, but they only play up to three movies and it could even be just one movie depending on your location. This extremely limits their market reach. Movie theaters thrive off of a wide variety of genres playing at the same time for example kids movies, comedies, action, etc. IMAX simply cannot offer this. Instead, they formed their own niche and specialized in an enormous 4D screen and sell tickets at a higher rate than the industry average. AMC doesn't need to worry about IMAX for those reasons.

Newly Issued Debt

AMC has decided to take on a significant amount of debt. This may seem scary to some investors but they are in a perfect financial state to pay off this debt. They will use this leverage to grow their revenues in the long run as well as reduce costs. Here are a few key financial stats pulled directly from AMC's and Cinemark's cash flow/balance sheets.

Source: Seeking Alpha

The top two lines are CNK and the bottom three is AMC. As you can see, AMC's net debt compared to CNK has seen a huge increase recently. However, I'd like to emphasize the last AMC line that shows that the majority of this newly issued debt is long term debt, so they will not need to use any of their liquid assets to pay off any new short term debt anytime soon. I love the aggressive long-term outlook AMC is taking here and do not think they will have any trouble increasing revenues and decreasing costs with these newly issued funds in order to grow their stock price and still be able to pay off their long-term debt.

How Relative Gross Margins and Capex Can Increase Growth

If AMC is Burger King, Cinemark is McDonald's. Cinemark is consistently generating higher net incomes, contains less debt, and is more financially sound. AMC's last three years of change in cash flows however are as follows 102,900 (2017), -4,100 (2016), -7,000 (2015). Compare that to Cinemark's, which is -38,688(2017), -27,304(2016), -50,330(2015). This was very interesting to me when analyzing these companies financial statements; however, cash flows from operating activities relative to these two companies are quite similar. I primarily want to focus on gross margin for both companies.

Source: Yahoo Finance

On the top you have AMC and on the bottom CNK. One of the biggest problems that AMC has is their costs. Cinemark is able to manage 525 locations while AMC only has 380. AMC needs to find a way to drive down these costs. If they can do that, they will be able to achieve much prettier margins then CNK. Something that makes me optimistic about AMC's future is their increase in capital expenditures. In 2017, Cinemark had a capex of 380,862, while AMC had a whopping 626,800. This is understandable as Cinemark has less of a need to open new locations, while it appears that AMC is aggressively spending their retained earnings on opening new locations. This could also mean that AMC is investing money into research to try to drive costs down in the long run.

Now, let's look at a five-year chart comparison to analyze why I believe AMC is a great growth stock compared to Cinemark.

AMC's Price Lag

Source: Tradingview

Here we have Cinemark in blue, and AMC in red. As you can see, these two stocks basically mirrored each other until August 2017. The two stocks still mirrored each other, but just had a greater spread between them. I see this as an opportunity to take advantage of a growth stock with a excellent dividend yield. 2017 was a rough year for the entertainment industry, especially the movie industry. Like I mentioned before, people began to realize a plateau in sales numbers, and what appeared to be a changing demand for streaming services like Netflix (NFLX) and Hulu over going to the movies.

Well, I believe that after one of the strongest years ever for the movie industry, both of these stocks have room to rebound over this next year. It is important that you note "this next year" because I really do believe that movie theaters will see a decline as our streaming service technology matures a little bit more. This serves as a possible risk for the upcoming year. It is possible that while movie theaters sales will grow, the market will price in their future doubts despite the growth. I simply think the market jumped the gun trying to predict this decline however. Also, if you analyze the two stock charts more recently, it appears that AMC is slightly lagged in their growth spike compared to CNK. I am expecting AMC to eventually rebound and catch up to its competitor in Cinemark.

New Industry Approaches

While I love both companies during this next year, the reason I am leaning toward AMC is because they are simply lagged in following the footsteps of their competitor, Cinemark. They have less locations and are spending much more than Cinemark to try to expand an get to Cinemark's level. AMC's stock price is much cheaper, which fits better for my covered call strategy (which I will get into next), allowing people who maybe do not have a significant amount of cash to invest in this industry.

I also love how AMC is adapting to the new "way of movies," which is having a subscription option that gives you many benefits. AMC's subscription service is called Stubs A-List, and Cinemark's is called Movie Club. Here is what AMC's subscription consists of: $20/month, 3 movie tickets per week, free online reservations, and 10% back on concessions along with a free size upgrade on popcorn and drinks. Here is Cinemark's: $8.99/month, one free 2D movie ticket a month (missed tickets rollover), 20% off all concessions, and free online reservations.

I see much more value in AMC's deal, and here is why. Usually moviegoers are movie fanatics, they love the experience, and will go to any movie just to be in the theater. AMC's tickets for one movie usually range from $11.99-$14.99. If you are going to go their consistently, it is a no brainer to pay just $20 a month for 9 movies. Whereas Cinemark's is cheaper yes, they only offer one movie per month for a slightly discounted price. Obviously it all comes down to whether you think you will actually see nine movies a month, but I firmly believe that AMC's Stubs A-list is a much better deal then Cinemark's Movie Club subscription.

Remember how I mentioned that even if people prefer an AMC theater over Cinemark, but the Cinemark theater is less of a commute, this will most likely drive them to go to Cinemark. Well, AMC's superior subscription service deal could potentially draw some of these customers to travel the extra few miles to attend AMC theaters over Cinemark. Again, I still love both of these stocks going into this next year, I just think AMC has the opportunity to mature and grow more than Cinemark given their recent lag in stock price.

Fixed Income Strategy

I will now explain how you can generate nice monthly premiums by taking advantage of AMC's potential growth this year, and very strong dividend yield. First, I suggest buying 10,000 shares of AMC stock. If that is too many shares 100 will do. It all depends on the amount of risk that you are willing to take. AMC is currently sitting at a 4.95% yield, which is about .80 per share. So, assuming the stock is trading exactly where it is today (obviously just a theoretical example) you will get a check for $8,000 every time they pay off a dividend. Obviously, this number can be slightly lower or higher, but this is what we are assuming for this example. I like to ideally use the dividend payouts as extra returns, but they also serve as a great safety blanket if our shares were to decrease in price.

Next, assuming you have read this article and others and truly believe that AMC will steadily grow throughout this next fiscal year, I suggest writing covered calls, slightly in the money (slightly above what you bought the stock for) on this stock. For example, if you bought 10,000 shares of AMC at 16.60, I would suggest selling the 17.00 calls for the next month. These will usually generate .90-1.50 premiums, which equates to about 10,000 per month, assuming we are not called out. The reason I say sell slightly in the money calls is because assuming we are called out, we would not lose any money, and be "forced" to sell off our shares, but still at a profit.

The only way to lose money on writing covered calls is if the stock drops, which will result in you still receiving the premium, but the value of your current shares will decrease. However, like I said before, our $8,000 dividend payout and premiums will hopefully be able to cover our loses and still enable us to take advantage of this potential growth. I would suggest writing these calls all the way up until you do not think there is any more room for growth. Then you cash out by selling off all of your shares. If you have the capital, I would also suggest doing this strategy on shares of Cinemark, as they also have a strong dividend yield of 3.34% which is about $1.36 per share.

Also, if you are able to take on the risk, I highly suggest trading on margin, which will significantly raise your stake in the company and boost returns. Without margins, however, if you were to successfully receive your premiums every month, this would result in a 6% return per month strictly from premiums received, the dividend serves as either bonus returns, or a safety blanket to cover losses.

I will now try to make these covered call strategies as simple as possible for readers who might not have much experience with options. (If you have experience selling covered calls, you can skip this section.) When you write a covered call, you are giving someone the right to buy your shares at a certain price (strike) over a specified period of time. The term covered comes from you already owning these shares, so therefore you are covered. If you are not covered (you don't own the initial 10,000 shares) then you will be forced to take a massive amount of money out to buy the shares and sell them at the strike price. Uncovered calls are called naked calls. If I could give any advice to new option traders, I would say never write naked calls as they can turn into a disaster.

Moving on, let's assume that you did buy the 10,000 shares to cover yourself, and let's say you bought the stock at 16.60, like I said above you would write covered calls on the $17 strike that expires in about a month or month and a half. The other side of the trade, is someone buying the right (buying a call) to buy the stock at that strike price. The price that they have to pay for to gain the right to buy the stock at that price is the premium that we are receiving on our side of the trade.

Let's say that when the option contract expires, the stock is trading at 17.80. It went up just like we expected. This will result in us getting "called out," which means we have to sell all of our shares to the person on the other side of the trade at the stock price. What makes this strategy so nice, is that while getting called out is usually a bad thing, in our situation, it is a great thing. It is great because we bought our initial shares at 16.60 and now are forced to sell them at 17.00 per share. This results in a .40 profit per share along with the 1.10 (made up premium) that we received as a premium. The stock went up 1.20, but we made 150, and will still be able to take advantage of our dividend payouts.

Now, let's say that when the option contract expired, the stock decreased to 15.50. The person buying our call's contracts would expire worthless, but we would still receive the 1.10 premium and hold our shares. When this happens, the premium helped us breakeven and avoid loss (-1.10+1.10=0), and while this is happening, we will still receive our dividend payout. No matter what happens though after one options contract expires, immediately write another covered call on strike prices slightly above what you bought the stock for. As long as you believe the stock will still increase over time, this strategy will almost always prove to make you positive returns.

Conclusion

I am very optimistic for growth in the movie industry during this upcoming year. Movies that have proven to be very successful are coming out with sequels, and one of the most anticipated movies of all time is coming out this year in "Avengers: End Game." While Cinemark and AMC are both leaders in the industry, after analyzing the companies financials, it appears that AMC is on track, yet lagged in the sense of keeping up with Cinemark. Increased capex is a good start, but I am still looking for a plan from management to cut COGS over the next couple of years.

Despite their high costs, I believe their stock price will eventually catch up to where it was in 2014 to basically mirror Cinemark more closely like it used to. A newly created gap in their prices seems to be a great opportunity to jump in and own some AMC. I believe their new Stubs A-List subscription service is far superior to Cinemark's, which might have come at the perfect time looking at some of the highly anticipated movies coming to theaters in 2019. AMC will look to strongly grow over 2019, and I believe the best way to take advantage of their attractive margins is to buy the stock and sell covered calls on it until you think there is no more growth potential.

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.