Over the past couple of weeks, the operating environment for the cinema industry has changed dramatically. As a result, I have become bullish about the outlook for the Cineworld (LSE: CINE) share price.
However, while I think the company’s outlook has improved significantly, I am not yet willing to go all-in. I think this is more of a speculative investment because there is still plenty that could go wrong for the business over the next couple of years.
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Cineworld share price risks
Over the past couple of months, as the UK economy has gradually reopened consumer confidence has steadily improved. Whenever I have covered Cineworld in the past, I have always tried to clarify that enticing consumers back into its theatres is the group’s biggest challenge.
There are many reasons why theatregoers may not return. Online streaming services have boomed during the pandemic, and producers are now releasing films straight to these services, bypassing cinemas.
At the same time, with Covid-19 still present in the general population, some consumers may be concerned about sitting in a large auditorium with hundreds of other people.
What’s more, inflationary pressures are increasing the costs of going out. These pressures could cause consumers to cut back on spending, thereby reducing custom for Cineworld.
As well as these actions, which are outside of the organisation’s control, it also has to manage some internal factors. Over the past 18 months, the company’s debt obligations have risen substantially.
Paying the interest bill on these obligations is going to be a challenge. High interest charges suggest the company can’t just return to 2019 levels of sales. It has to surpass these figures significantly to meet creditor obligations and stay profitable.
Considering all of these headwinds, it is no surprise that investors have been avoiding the Cineworld share price. However, it is looking as if consumers are not just returning to theatres, but they are also returning in greater numbers than in 2019.
According to data released at the beginning of November, consumer spending increased by 14.2% in October compared to the same period in 2019.
Spending grew in almost every section of the economy. Cinema bookings hit their highest level of growth since October 2019. Data from Barclaycard showed that bookings increased 17.3% compared to the same period in 2019.
Cineworld later confirmed this data. According to a trading update published in the middle of November, box office and concession revenue at the group’s cinemas in the UK and Ireland totalled 127% of 2019 levels in October.
Unfortunately, these figures were not repeated across the business. Sales in the US, Cineworld’s largest market, were just 80% of 2019 levels in October. In the rest of the world, sales came in at 84%. Overall group revenue was 90% of 2019 levels in October, up from 60% in September.
I think these figures show an interesting trend. While the company’s performance outside of the UK and Ireland is relatively disappointing, it is notable that in these two markets, consumers are splashing out.
That suggests that when the rest of the world starts to reopen as the UK has done, and consumer confidence starts to return globally, Cineworld’s sales could increase substantially from current levels.
Of course, this is not guaranteed. There are plenty of headwinds that could delay the global consumer bounce back, some of which I have outlined above.
Still, I think the trends in the UK and Ireland are worth keeping an eye on. This is the main reason why my opinion of the Cineworld share price has shifted recently.
If the trends seen in the UK and Ireland persist throughout 2022 and spread around the rest of the world, the company’s sales and profit expectations could surpass expectations.
This would produce more cash for the group, which it could use to start reducing its enormous debt pile.
This is another significant risk that the corporation will have to deal with. Until it does, I think the market will continue to view the business with a certain level of caution. Too much borrowing is one of the primary reasons why companies fail.
Cineworld’s net borrowings, excluding cash, totalled $4.6bn (£3.4bn) at the end of June. To put that into perspective, the company’s current market capitalisation is just £785m.
Management has said the company is pursuing options to reduce this borrowing. These include a potential listing of the US business. As the group’s largest division, this could unlock a significant amount of capital to reduce debts. Unfortunately, there would also be costs associated with the separation.
Nevertheless, the firm needs to start bringing its borrowing under control. In the first half of 2021, financing costs amounted to just over $400m. The company is on track to spend $800m for the entire year maintaining its borrowing.
If revenues do make a significant recovery across the group and rise above 2019 levels in 2022, Cineworld may be able to start chipping away at its debt mountain. I think the chances of this scenario playing out have increased substantially. Recent consumer spending data and the company’s own trading updates support this thesis.
The Cineworld share price as an investment
This is the best-case scenario for the group. An alternative scenario would be a spin-off or sale of the US business. This would help the company reduce debt, but it is difficult to say how the business would look after the transaction at this point in time.
Whichever course of action the company decides to take, I think the outlook for the Cineworld share price has changed for the better over the past couple of weeks.
And while the business will continue to face some challenges, I would be happy to buy the stock for my portfolio as a speculative recovery play today.