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Is Now a Good Time to Buy Shares of Cineplex (TSX:CGX)?

Cineplex (TSX:CGX) stock was trading at high levels for a long time. It had a superb run from 2009 to mid-2017, delivering 20% per year and transforming a $10,000 investment into more than $47,100!

Its high returns had partly to do with its big yield, which remains attractive today. Another factor was that it had multiples expansion.

Is Cineplex trading at a cheap valuation?

Cineplex stock always appeared to be expensive based on its price-to-earnings ratio (P/E). Its P/E was as “low” as 25 during the last recession and as high as 45 in 2017 before the stock had a major correction.

In comparison to its historical trading level, the stock is relatively cheap with a blended P/E of about 24.5 at $23.88 per share as of writing.

The stock has been more reasonably valued based on its price-to-cash flow ratio, which was as low as 5.4 during the last recession and as high as 21 in 2017.

Currently, the stock trades at a blended price-to-cash flow ratio of about six. So, it’s relatively cheap. What’s more to like is that its forward multiple is estimated to be under 4.9, which makes the stock even more compelling from a valuation standpoint.

Is Cineplex’s high yield sustainable?

Because CGX stock has fallen so much, it now offers a whopping yield of 7.5%, which is paid out in the form of a monthly dividend. This is way higher than its five-year average yield of about 4.1% and is another indication that the stock is cheap.

In most years, Cineplex’s dividends weren’t sustainable based on the earnings the entertainment company generated. However, they were sustained by its cash flow generation. For example, over the last 12 months, Cineplex paid out 65.2% of its adjusted free cash flow as dividends.

Cineplex’s dividend track record is also decently strong, which shows its commitment to the dividend. It has maintained or increased its dividend every year since 2005.

Management has strong confidence in the future of the company, as it just hiked its dividend by 3.4% in May. The new dividend equates to an annual payout of $1.80 per share.

Concerns

Cineplex’s investments into other areas of entertainment are diversifying the company’s revenue away from theatre-related revenues. There was year-over-year 7.7% growth in media revenues and 17.2% growth in amusement and other revenues in the first quarter. However, they still only make up a small part of total revenues compared to the box office and theatre food service revenues, which together contributed about 69% of total revenue in the first quarter.

Cineplex’s rising debt levels is another concern. In the first quarter, the company’s long-term debt more than tripled to $1.9 billion, which results in a net debt to EBITDA of about 6.5.

Foolish takeaway

Cineplex’s diversification strategy doesn’t seem to be executed fast enough to offset the lower theatre-related revenues. In the first quarter, total revenues declined by 6.6%. Moreover, the company took on a lot of debt for the investments.

As a result, Cineplex stock trades at a valuation that’s near recession lows. Cineplex stock isn’t for conservative investors. However, investors with a bigger appetite for risk may be able to get outsized returns from the stock over the next five years. Just remember to size your position properly, such as not having more than 1% of your portfolio in the higher-risk stock.

Here’s a sense of the returns you can get. Thomson Reuters has a mean 12-month target of $31.20 per share on the stock, which represents near-term upside potential of about 30%. Additionally, the stock offers a high yield of 7.5%.

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Fool contributor Kay Ng owns shares of CINEPLEX INC.

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