The Popcorn Investing Strategy

There are many good businesses trading at attractive levels at the moment. One such example could be Cineworld (LSE: CINE) . Today's results show a business with a P/E of less than 9 and a yield of over 7%.

Founded in 1995, the company is the second largest chain of cinemas in the UK with 74 locations and a 24% market share. Odeon, which is owned by Terra Firma, is the largest with around 100 cinemas. Cineworld joined the market a year ago, issuing shares at 170p. They spent much of the last year north of £2 but then fell away sharply. They are currently trading at 133p, valuing the business at £189m.

Some cinematic history

Cinema attendances have changed dramatically over the years. They peaked in the UK in 1946 when we made almost 1.5b visits, which meant everyone in the country was going once a week. A long-term slump followed until 1984 when the number of admissions fell to 54m.

Since then, despite the rise of video, pay TV and DVD, admissions have steadily recovered to 160m with gentle growth predicted over the next few years. As you might expect, this means Cineworld's expansion plans are sedate to say the least with just two new cinemas opening by the end of 2009.

I'm a semi-regular at its Stevenage unit. Not only was this the first cinema Cineworld opened, it was reputedly once responsible for over half the pirated films in this country. Classy!

Drama in the ad break

Personally, ads at cinemas drive me potty. But they are an important source of revenue. Traditionally, cinemas make approximately 70% of their money on ticket sales, 20% via retail and 10% from advertising.

In December, Cineworld shares fell 20% in one day when it revealed that Carlton Screen Advertising, owned by ITV, wanted to restructure its long-term deal with the company. This may yet have a silver lining though, as Cineworld has teamed up with Odeon to form an advertising joint venture called Digital Cinema Media. It describes the prospects for this move as "exciting" although it is yet to be approved by the competition authorities.

Dicing with debt

The major negative with Cineworld is its level of debt. As it was previously owned by a private equity firm it came to the market laden with the stuff. It still has a £129m bank loan, due to be refinanced in 2012. Instalments of £9m a year are repayable until that time and interest is charged at 1.35% over LIBOR. Although it's undesirable, it looks manageable to me.

If times do get tough, I suspect cinema attendances won't be affected too dramatically in the short term. There are new Bond, Harry Potter and Narnia films out later this year and the usual smattering of cartoon heroes in the summer such as Iron Man, Hulk and Batman. If these disappoint, then we have a wrinkled Indiana Jones that can ride to the rescue. If you get impatient waiting for trading statements then you can always look at the weekly UK box offices figures to get an idea of how the company might be doing.

Like many recently floated companies, Cineworld's profit and loss account is a bit of a mess with many one-off items obscuring the underlying performance of the business. Prior to these results estimates for next year were for profits of £30m. This would result in earnings per share of 15p and a P/E of just under 9.

One major sign of confidence from management is the first-year dividend of 9.5p, including the 6.5p final dividend declared today. This puts the shares on a juicy dividend yield of 7.1%. Despite the high level of debt, there is enough value here to make the shares worthy of a nibble.