In the early 1990s, skeptics said the days of cinema were numbered as video rentals grew and recession hit. But what they failed to appreciate is the enduring appeal of watching blockbuster movies on the big screen, while tucking into popcorn and ice-cream. In fact, cinema audiences have been rising steadily over the past two decades or so, from 68 million in 1985 to 108 million in 1995, to around 175 million today – an organic growth rate of around 3.5% a year. So even in austere climes, the industry has proved resilient.
Cineworld ( CINE
), tipped as a BUY by Altium Capital
One way to play this durability is via Cineworld, the second-largest chain after the Odeon, with a 23.7% share of the UK market. It owns 74 sites with a total of 770 screens, including five out of the eight highest-grossing locations.
The company floated at 170p last April and reached an all-time high of 227p in September. The stock has since fallen on fears of tightening consumer spending and the renegotiation of an advertising deal with ITV, but I believe the sell-off has been overdone. Here’s why.
First, cinema still offers one of the cheapest forms of entertainment around, especially compared with eating out or going down the pub. So as long as good films are being made, punters will keep lining up. In 2008 there is a rich slate of potential blockbusters being released, including new Batman, Harry Potter and Indiana Jones films.
More specifically, concerns over an ITV advertising deal seem to be overblown, as the issue was resolved in March. Both Cineworld and the Odeon agreed to set up a joint venture to bring the operation in-house, helping each other to protect future earnings while also allowing customers a broader range of promotional options.
Digital technology is driving demand too. For instance, Cineworld signed a deal in October to offer 3-D films at 30 of its 74 venues. This is important because 3-D movies (such as Beowulf) typically generate higher box-office sales. The group is also expanding its leisure activities into theatre productions (such as Brief Encounter) and live entertainment, such as broadcasts of U2 concerts and New York Opera.
The City expects 2008 sales and earnings per share of £295m and 13.1p respectively, rising to £303m and 14.8p in 2009. At last week’s results, chief executive Stephen Wiener said the year “had started well and attendances were strong”, with the outlook “promising”. The stock trades on undemanding p/e ratios of 9.9 and 8.8 and pays a hefty 7.3% dividend yield – which to me looks too cheap.
So what do we need to watch out for? The main risk is that Cineworld’s expansion plans are knocked off course by a very tough economic slump. There is also a possible stock overhang issue, as Blackstone owns a 53% stake. Longer term, there are fears over the growth of home-cinema systems and the trend towards selling DVDs sooner after films are first released.
The group is also operationally leveraged and had net borrowings of £124m at the end of 2007, although underlying interest is still covered a comfortable 3.5 times. What’s more, the debt relates to a five-year term loan at 1.35% above Libor, which ends in 2012 – so there is no immediate issue over short-term funding, unless banking covenants were unexpectedly breached.
Recommendation: speculative BUY at 129.75p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments