Warning! This popular UK stock may be about to crash

Cineworld continues to recover at an encouraging pace., but Zaven Boyrazian has discovered a problem that could send the UK stock plummeting.

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All too often, UK stocks can gain popularity among investors for the wrong reasons. One, in particular, that’s come to my attention is Cineworld (LSE: CINE). Some analysts are predicting the stock can climb from 43p today to as high as 125p within the next 12 months. And on the surface, that certainly sounds like a perfect pandemic recovery play. But after a closer inspection, I think it’s far more likely that the share price is on the verge of crashing. 

Let’s start with the positives of this UK stock

The crash of the Cineworld share price in 2020 is pretty self-explanatory. The pandemic forced most cinemas in the UK and US to close for a considerable amount of time, wiping out the company’s revenue stream in the process.

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Today, the situation has drastically improved. Cinemas have reopened their doors. And thanks to a lot of pent-up demand along with an extended list of delayed blockbuster titles, attracting crowds back to the big screen hasn’t been too challenging.

Looking at the latest trading update, films like Spider-Man: No Way Home, Dune, and No Time To Die have restored Cineworld’s revenue stream to 88% of pre-pandemic levels. That’s certainly an encouraging sign of recovery. And with further titles, including Death on the Nile, Uncharted, and The Batman scheduled to be released in the next couple of months, ticket and concession sales should be able to continue climbing.

That’s obviously a positive sign. So why do I think this UK stock is about to collapse?

Getting into the weeds

While revenues might be close to returning to pre-pandemic levels, the boost in cash flow is simply not enough to stay afloat. Cineworld’s growth strategy over the years has been highly acquisitive. This is actually how it became the world’s second-largest cinema chain. But as a consequence, management racked up a lot of debt. And the pile only got bigger when the pandemic struck.

As of the end of June last year, the company had $8.8bn (£6.5bn) of loans on its balance sheet. And that comes with a $548m (£402m) annual interest bill. Assuming the company can return to pre-pandemic levels of profitability, operating income will stand at around $725m (£532m).

That’s enough to cover the interest expense, right? No, because Cineworld also has $629m (£461m) of leases to pay as well as a handful of other short-term liabilities to deal with. As it stands, the firm simply doesn’t have enough cash flows or liquidity to pay its bills on time.

To make matters worse, it’s just been slapped with a $970m (£705m) legal fine for pulling out of a signed deal to acquire Cineplex in 2020. This doesn’t bode well for the UK stock or its shareholders.

What now?

The renegotiated debt covenant state the company needs to have a net debt that is no more than five times EBITDA by the end of June 2022. As it stands, I just don’t see that happening.

I could be wrong, of course. But if it defaults, creditors could force a debt trade for equity, triggering a financial restructuring. Large chunks of debt could be wiped clean, with new shares flooding the market. But this would lead to enormous equity dilution, denting the stock’s price in the process.

Needless to say, I’m not adding that risk to my portfolio.

Instead, I'm far more interested in buying shares of another UK stock that could be set for triple-digit returns in the next few years...

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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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