Cineworld (LSE: CINE) is a FTSE 250 company whose share price has declined from its previous high. However, City brokers are forecasting good earnings and dividend growth this year and beyond. Such situations can be a great opportunity to buy into a growing business at a bargain price.
Cineworld trades at just 8 times forward earnings with a 7% dividend yield. Should investors jump in? Or is the valuation simply too good to be true? Here, I’ll discuss why I think the market is rating the stock so cheaply. And whether I think it’s a bargain buy or one to avoid.
Growth
Cineworld was floated on the stock market at 170p a share in 2007. It was a small-cap company, valued at £241m. Today, the share price is 183p and the market capitalisation is £2.5bn.
The reason for the much larger increase in the market cap than the share price is that Cineworld issued shedloads of new shares (from 142m at flotation to 1.4bn today). It did this to raise cash for acquisitions.
Two years ago, it completed a $3.6bn reverse takeover of Regal Entertainment in the US. Yesterday, shareholders also approved a $2.1bn takeover of Canada’s largest operator, Cineplex.
Falling ticket sales
Cineworld’s management has certainly shown ambition. But I think the market may see a danger of, in the words of Macbeth, “vaulting ambition, which o’erleaps itself.” For one thing, the company has taken on a welter of debt. For another, cinema attendance in North America appears to be in structural decline, with a two-decade trend of falling ticket sales.
Notably, ever fewer teenagers and young adults – historically, the biggest demographic of movie-goers – are visiting cinemas. Studies show this is true not only of North America, but also other major markets, like the UK and Germany. The fact that cinema-going habits are formed young and remain as we age is a big concern for the future.
Bucephalus
I’ve written before about Cineworld’s high level of debt ($3.3bn, and gearing of 3.3 times EBITDA). I also suggested debt may be one of the reasons why Cineworld is one of the most heavily shorted stocks on the London market.
Debt isn’t the only reason, according to Bucephalus Research Partnership, which specialises in identifying companies where it believes creative accounting is shielding a weak underlying business.
I haven’t yet managed to get hold of Bucephalus’s report – titled ‘Cineworld: Looking like a horror show’ – but there’s a six-minute summary presentation on the research firm’s YouTube channel.
Among other things, it reckons Cineworld has “taken full advantage of the Regal deal and the change in lease accounting to get extremely creative … This has flattered their growth, buried costs, inflated margins, and obscured $2bn of debt and liabilities from the balance sheet.”
Bucephalus suggests Cineworld’s gearing – on a true view – is absolutely eye-watering. Namely, over 9 times EBITDA.
Bottom line
Even if I dismiss Bucephalus’s analysis, I still see Cineworld as a stock to avoid. I don’t like the headwinds of declining cinema attendance in North America, and among young people across many major markets. On top of that, the company’s debt and gearing (on management’s own presentation of the accounts) are too high for my liking, as are the sheer number and weight of short positions in the stock. There are better high-yield prospects around, I say.
