It’s been a tough year for the Cineworld (LSE:CINE) share price. Despite recent double-digit jumps, the stock is still down around -75% since January. The cinema chain closed all its locations across the UK and US due to the delay of blockbuster titles like the new James Bond film, No Time to Die, and Wonder Woman 1984.
What caused the Cineworld share price to fall?
With no new hit films in the pipeline and most people remaining at home to avoid risking falling ill, the business elected to hunker down to try to weather the storm. The most recent estimates suggest that branches will reopen in early Q2 of 2021.
The announcements of several Covid-19 vaccines have been the driving force behind the recent climb of the Cineworld share price. However, even if a vaccine were available tomorrow, I think the stock is in serious trouble.
It owes a lot of money
Before the pandemic, Cineworld was the second-largest cinema chain in the world with over 790 locations. Its vast size originated from a merger and acquisition strategy that management has been employing for many years.
I’ve previously mentioned my reservations with such growth strategies, and this business is a prime example of why. Cineworld funded these acquisitions almost entirely using credit facilities. As a result, even before the pandemic hit, the firm had over $7bn of debt.
Alone this means nothing. However, over the same period, operating profit was a mere £725m. Of that, £499m went to cover interest payments. So, Cineworld spent over half its underlying profits to cover its debt obligations, with virtually no reduction to the principal owed. This does not bode well for the Cineworld share price.
Cineworld is still borrowing more!
Today, the situation is much worse. While closing branches certainly reduced operating expenses, the fixed costs, such as rent and utilities, haven’t gone anywhere. Cineworld has been negotiating with landlords for a temporary reduction on its leases. But it’s still unclear whether this will bear any fruit.
With no revenue, the business once again is having to rely on additional debt financing. It recently secured a new $450m loan to see it through the winter, as well as lift the covenants on its existing debt until June 2022. Now Cineworld owes nearly $8.5bn, with debt representing 87% of the firm’s capital structure.
This is a huge red flag in my eyes. Debt covenants are put in place to protect debt holders. They are restrictions designed to prevent the borrower from becoming overleveraged. Given the firm can barely keep up with existing interest payments, the additional debt is only going to add more pressure on the bottom line.
Is the current Cineworld share price a trap?
I think the Cineworld share price is almost definitely a value trap, and I will be avoiding it. Beyond the debt problem, Cineworld is currently being sued for backing out of a $2.8bn acquisition before the pandemic hit.
I would not be surprised if the company declares insolvency in the near future. If it does miraculously survive, I believe it’s going to be a long time before the share price returns to pre-Covid-19 levels.
