Back in July, I warned investors that it was probably time to sell Cineplex Inc. (TSX:CGX). I gave four reasons why tough times were ahead of the company. Shares are now down ~20% since my warning, and it appears that no bottom is in sight, especially considering that the Canadian market has been a huge laggard this year. Although there are many headwinds working against Cineplex, the recent plunge has resulted in shares of CGX having the highest yield they’ve had in quite a while.
Many income investors may view this dip as a long-term buying opportunity, but before jumping into the deep end, it’s important to understand what the company will be facing over the medium to long term to have a good estimate of where shares are headed.
What triggered the ~26% plunge?
The company delivered a very underwhelming second-quarter earnings report, which saw net income decrease by 80.9% on a year-over-year basis. Diluted earnings per share were 83.3% lower compared to the same period last year, and attendance also down year over year, despite the strong lineup of movies in Q2.
Lack of growth prospects in the movie business
The movie and popcorn business is a ridiculously old industry, but Cineplex has managed to reinvent the movie-going experience with all of its innovative ideas over the past few years. VIP cinemas, arcades, DBOX, and, more recently, the Rec Room, and golf. The management team has done a terrific job, but there’s only so much juice you can squeeze out of a lemon.
When you take a look at the long-term picture, you’ll see that box office and concession revenues have been accounting for less of Cineplex’s overall revenues over the past couple years.
Why is that?
There’s very little room to innovate and spark growth in the movie and popcorn business. Cineplex is now, at best, a slow-growth income-paying stalwart, but investors have grown to love Cineplex for its ability to continue to grow.
What now?
Over the long term, I expect box office and concession revenues to account for even less of Cineplex’s overall revenue, as the company makes moves to become an entertainment company that doesn’t just specialize in movies.
Millennials value experiences, and Cineplex has an opportunity to give them more fun things to do to encourage more Canadians to go out and watch a movie.
Cineplex has many headwinds working against it, so shares will continue to get hammered until they trade at more reasonable valuations.
Is this it for growth?
I don’t think so. Cineplex is facing a tough roadblock here, but I’m confident it’ll pull through over the long term once the management team makes more partnerships with general entertainment companies.
In a decade from now, it’s quite possible that Cineplex will be the go-to entertainment company. But this is going to take some time. In the meantime, I believe shares are going to continue to get hit.
Bottom line
If you’re a long-term investor who wants to take a bet on Cineplex, then it may be wise to wait it out, because I think shares will continue to get hammered. Once shares of CGX start yielding closer to 5%, then it may be time to start buying on the way down using a dollar-cost averaging approach.
Stay smart. Stay hungry. Stay Foolish.
