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Cineworld shares are rising: Here’s what I’m doing

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In my article on Cineworld Group (LSE: CINE) last Friday, I looked at reports the firm was seeking rescue financing and explained why I’d stay away from this stock. In the days since then, Cineworld shares have surged 35% higher, thanks to a new $450m loan that should fund the company through to reopening.

Was I wrong to avoid Cineworld? Today I’m going to take a fresh look at the world’s second-largest cinema group and explain why I’m not changing my mind just yet.

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New debt gives breathing space

Before Monday’s news, press reports were suggesting that Cineworld might have to close some cinemas permanently and beg landlords for rent reductions. That risk seems to have gone away, at least for now.

The company says that it’s secured $450m of new debt and agreed extended repayment terms on some existing loans. Management believe the firm will now have enough cash to survive, even if cinemas stay closed until May 2021.

I’m not surprised that Cineworld shares have popped higher. I believe this is good news for the company and its shareholders. But I don’t think it’s a full solution to the cinema group’s problems.

Too much debt

Cineworld already had a lot of debt before the coronavirus pandemic got underway. The firm’s 2019 results show net debt of $3.5bn excluding leases. That figure rose to $4.2bn at the end of June. I think it’s likely to be closer to $4.5bn by the end of this year.

With most of the cinemas closed, Cineworld is burning through about $60m of cash each month. When cinemas do eventually reopen, initial trading may be slow. Current broker forecasts suggest the firm’s 2021 sales could be 30% below 2019 levels, leaving the group trading at a loss.

My sums suggest that reducing the firm’s debt mountain to a more sustainable level will be difficult, even if trading recovers quickly.

Cineworld shares: What next?

In my view, management have done well to negotiate this new loan. I think there’s a good chance Cineworld’s share price could rise further over the coming weeks. However, I’m fairly sure that this week’s funding deal will only be a stepping stone towards a wider refinancing.

At some point in the next year or two, I believe Cineworld will need to swap some of its debt for new shares in the company.

This might be done by selling new shares to existing investors. Or the firm’s lenders might agree to write off some of their loans in exchange for new shares in Cineworld.

In either case, I’d expect the new shares to be issued at a level below the share price at the time, causing the Cineworld share price to slump. Any existing shareholders who didn’t invest fresh cash would also see their stake in the company cut dramatically.

My policy on turnaround situations is to stay away from companies that have too much debt. In my opinion, that’s true here. For this reason, I’m going to continue avoiding Cineworld shares.

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Roland Head 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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