Thousands of screens, regular customers, and high profit margins on items like popcorn: Cineworld (LSE: CINE) seems to have the makings of a solid business. So why is the Cineworld share price trading for pennies, 64% below where it stood a year ago? Could it be a bargain buy for my portfolio?
Business and investment
The short answer is no, I do not think the Cineworld share price makes it a bargain. In fact I fear it could end up going to zero and certainly will not be buying the shares.
But why is that when the company has some obvious business advantages?
One things many investors fail to realise, especially when they first start investing, is that just because a business is good does not mean that it makes for a rewarding investment.
There can be different reasons for that, but in Cineworld’s case, the issue is the company’s balance sheet. A balance sheet shows a company’s assets as well as its debts. Cineworld’s is not pretty. The company ended last year with $8.9bn of net debt, an increase of around $0.6bn on the prior year. That compares to the current market capitalisation of £320m, which is around $390m.
Cineworld certainly has the makings of a good business in my view. But the balance sheet means it could potentially be a horrible investment, as we have seen over the past year. Debt costs money to service, in the form of interest. It also needs to be repaid at some stage. Last year, Cineworld paid $227m in interest. Even so, its debt pile still went up. Such a huge debt pile is a millstone around the company’s neck.
Improving business outlook
But what happens if cinemas start to get close to pre-pandemic customer numbers again? We have seen other leisure companies such as pub operators report revenues close to pre-pandemic levels again, so maybe cinemas will too.
Cineworld more than doubled its revenues last year. Although the first part of this year saw some impact from the Omicron variant, I think cinemagoers will continue to increase in numbers. In coming years, I reckon Cineworld could end up seeing ticket sales close to what it managed in 2019. It understands the movie business very well.
But although the business outlook may be good, the debt pile still sits menacingly on the balance sheet.
Where next for the Cineworld share price?
That debt is going to need to be repaid at some point. I have doubts that Cineworld can make big enough profits to do that any time soon. Next month, its interim results should provide some detail on how the business recovery is proceeding and perhaps things are getting much better than they have been.
But there is clearly a risk that, if the company cannot make far bigger profits in coming years, its lenders will look for other ways to get their money back when it is due. For example, that could involve swapping debt for shares, potentially sending the Cineworld share much lower. In a worst case scenario, I could see it going to zero and shareholders being completely wiped out.
