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Cineplex Inc.: The Valuation Is Rich, But Should Investors Still Buy the Shares?

I continue to struggle with the question of whether or not Cineplex Inc. (TSX:CGX) is a good buy at this point in time. The stock has been pretty much flat since the beginning of the year and has an almost 30% three-year return, and this is not even including the dividend. That’s great. But the problem is that at 40 times earnings, the stock’s valuation is rich and expectations are high. We need to figure out if this is justified. So, to help with this decision, let’s look at the key points.

Further growth in the exhibition business?

In the exhibition business, the company has made big strides, increasing premium products such as Dbox and VIP to 50% of total revenue from only 3% 10 years ago. Also, the product offering has been nicely diversified with alternative products such as opera, Bollywood movies, and Hindi and Chinese films being a big part of the offerings at many of the company’s theatres.

To give more colour on the effect of this diversity, management highlighted an AMC theatre they acquired a few years ago in Courtney Park in Mississauga, Ontario. This theatre was cash flow negative when it was acquired. After Cineplex acquired it, the company focused on getting to know the territory. They introduced Bollywood movies at this location, and it became one of the top Bollywood locations in North America.

This success notwithstanding, it appears that growth going forward in this area is more limited.

Rec Room opportunity

According to management, the Rec Room in Edmonton, which was a test for the company, has been performing really well. Cineplex benefits here from its national presence, its SCENE loyalty program, which has 8.3 million members, and the potential for cross selling and access to these customers. Management expects a 25% return on the big-box Rec Rooms and a 25% EBITDA margin, and they see a lot of growth in this area going forward.

In summary

The dividend yield on the stock is currently 3.5% — a very attractive level. And, while the company will continue to invest in the business, it will continue to pass cash on to shareholders in the form of dividend increases, which have been a yearly occurrence.

I think it’s fair to say that Cineplex is a quality company with a strong national presence, good competitive positioning and advantage, a good track record of being strategically forward-thinking and innovative, and a good track record of execution and returning money to shareholders as well as investing in the business.

But I can’t get past the valuation. I think it’s too high, and that any misstep by the company will send the shares in a nosedive. So, I would buy these shares on weakness, when valuation comes down to more reasonable levels.

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Fool contributor Karen Thomas has no position in any stocks mentioned.

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