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Why Cineplex Inc. Is Set to Outperform the TSX This Year

Analysts are once again predicting that the TSX will under-perform the American S&P 500 index for the fifth consecutive year, with Bank of Montreal estimating the TSX will only return 2.4% compared to 6.6% for the S&P 500.

The reason? Unlike the highly-diversified S&P 500, 31% of the TSX is weighted towards the energy and materials sectors, and these sectors are both expected to under-perform due to weak commodity markets.

Therefore, investors should look to other sectors for growth, and entertainment company Cineplex Inc. (TSX:CGX) is one of the high-quality names that should handily outperform the index in 2015. Here are three major reasons why.

1.Cineplex has a solid growth runway

When investors hear Cineplex, they often think of movie theaters, but Cineplex is actually a highly-diversified entertainment company, with traditional theater, premium viewing, gaming, food service, alternative programming, digital media, and digital commerce operations.

In fact, one of Cineplex’s primary objectives is to eventually generate 25-50% of its earnings before income, taxes, depreciation, and amortization (EBITDA) from “non-hollywood” sources, thereby reducing risk from poor box office performance.

Cineplex took a major step towards both its diversification objective and towards establishing a double-digit growth runway earlier this year by announcing its new “Rec Room” social entertainment destinations. These destinations will offer a wide variety of innovative gaming options, upscale dining, a live-performance auditorium style venue for various entertainment acts, as well as high-definition theater screens for sporting events or other entertainment programming.

These entertainment centres will target young adults, families, as well as corporate/group events, and with 10-15 centres expected to open over the next 3-4 years, and with Cineplex estimating EBITDA margins for each centre in the 25-30% range, analysts are predicting a collective $30 million addition to EBITDA by 2019 from the Rec Room initiative.

This initiative alone would therefore provide 14% growth 2014 EBITDA over the next four years, and this just one of several growth pathways Cineplex has at its disposal, with significant opportunities also available from digital commerce, digital media, as well as from expanding gaming, food service, premium experiences, and building new theaters.

2.Valuation

At first glance, Cineplex seems expensive, with a price-to-earnings ratio of 40.6, which is above its peer group. However, when Cineplex’s growth is factored in, as well as its dominant market position in Canada, and its unique status as a counter-cyclical defensive play, this multiple seems entirely justified and perhaps low.

Analysts are predicting a 2015 earnings per share of $1.70, which would represent an impressive 49% growth in earnings from 2014. This would, in turn, give Cineplex a low forward price-to-earnings (P/E) ratio of 26.8, which is well in line with its peers. Collectively, Cineplex’s peer group (which includes theater companies, entertainment companies, and diversified cinema companies), trades at a forward P/E of 30.5, which means Cineplex’s current valuation is justified based on its future growth. This also means Cineplex has room to grow its multiple.

In addition, Cineplex has a dominant market share in Canada (currently 80% of the industry), and the current boost in consumer spending from low oil and gas prices, as well as a lack of other investment opportunities on the TSX due to energy and materials weakness, should serve to attract investors and maintain current shareholders.

  1. Cineplex has a stable, growing dividend

Finally, Cineplex offers a strong, sustainable dividend. With a yield over 3%, investors can get an above average yield, without the risk inherent in many of the commodity-oriented TSX stocks with similar yields. Analysts are estimating free cash flow of $98 million for 2015, and with a current dividend of $93 million annually, Cineplex is able to maintain and potentially increase its dividend.

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Fool contributor Adam Mancini has no position in any stocks mentioned.

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