You’ve probably heard about the many stocks that lost significant value in the recent market downturn, and Cineplex (TSX: CGX) is one of them. The theatre chain is recovering from the pandemic. Its revenue and theatre attendance jumped over 400% and 850%, respectively, in the second quarter. However, after reporting its first positive net income since the pandemic, Cineplex stock fell 27.8% to a new 52-week low. What caused this dip? Is there a silver lining?
Why did Cineplex stock fall over 25%?
Cineplex stock’s dip began after it announced second-quarter earnings on August 11. Despite a positive net income, the stock fell as the shareholder deficit increased to $1.19 billion from $1.15 billion (which was reported on December 31, 2021).
The biggest concern for shareholders is the $1.8 billion debt against a $26.58 million cash reserve. This debt includes $967 million in lease obligations as rising inflation increased average rent, and the rising interest rate has made borrowing expensive. Cineplex paid $28 million (or 8% of revenue) in interest expenses alone in the second quarter. Moreover, the government has removed its fiscal support, increasing its expenses.
The theatre chain has amended its credit facility for the fifth time, where creditors have extended the suspension of debt covenants. Covenants are requirements the debtor has to meet to reassure the creditor about its capacity to pay interest. One such covenant is that Cineplex maintains $100 million in liquidity at all times until March 31, 2023. This hints at a higher credit risk as creditors secure their interest payments.
Cineplex was hoping to claim $1.3 billion in monetary damages after Cineworld refused to acquire Cineplex in mid-2020. This case was in litigation; the court found Cineworld breached the contract and ordered it to pay damages to Cineplex. But on September 7, Cineworld filed for bankruptcy, thinning Cineplex’s chance of receiving the claim.
If Cineplex wins the claim, this could significantly reduce its debt and boost its stock price. While debt continues to be a factor that’s keeping risk-averse investors away from Cineplex, the recession is yet another factor that’s adding to the stock’s current unattractiveness.
Is entertainment immune to a recession?
This question is a hot topic of debate. A 2018 article in the Hollywood Reporter presented analyst arguments on both sides of the coin. Peter Tempkins, managing director of HUB Entertainment Solutions predicts that movies and live events will be recession-resilient as people need entertainment to “get their minds off the economy.”
But Harold Vogel, author of Entertainment Industry Economics: A Guide to Financial Analysis, says, “Once people have less disposable income, there are issues like housing and food that require more attention than entertainment.” Plus, some observers believe things could be challenging for movie theatres due to the wide availability of in-home and mobile streaming.
Is there a silver lining to Cineplex’s dip?
Considering Cineplex’s theatre attendance, I don’t expect a significant drop in audience. But what concerns me is the ticking clock of debt covenants. Interest expense is eating up profits. Cineplex is in dire need of favourable debt terms, but the market is not willing to meet this demand. Capital is scarce, and investors are risk-averse.
Cineplex stock is risky from a fundamental perspective. Its market capitalization of $560 million is less than one-third of its $1.8 billion debt. Its major upside is the $1.3 billion claim from Cineworld. Cineplex’s current stock price of $8.3 might look attractive, but the highest this stock can go is $11-$14. So if you want to play a speculative bet, you may buy some Cineplex shares (less than 1% of your portfolio and sell them at $11 (a 30% return).
I won’t hold this stock for the long-term as the growth prospects are limited. Cineplex was the target of acquisition before the pandemic. Hedge funds shorted the stock to make money. In derivatives, a person with a short position earns money when the stock price falls.
If you’re looking for long-term stocks with better growth prospects, consider RioCan REIT, which leases space to theatres and retailers.
