Dr. P.V. Viswanath
Four Boffo Ways to Play the Box Office
Barron's, January 12, 2013
Theater owners Regal Entertainment, Cinemark and EPR Properties, a REIT, offer steady cash flow and yields up to 6.5%. And Carmike, up 133% last year, could continue to grow.
Shares of the top three listed movie-theater companies gained an average of 63% in the past year, upstaging the broad stock market and most asset classes. Domestic box-office receipts in 2012 surged 6%, to $10.8 billion, a record. This year looks strong, too, and cinema shares likely have further to run.
There's Regal Entertainment Group (RGC), the stalwart, with a rich 5.9% dividend yield and a history of paying special dividends as well; Cinemark Holdings (CNK), which yields 3% and collects one-third of its revenue from fast-growing Latin America; and Carmike Cinemas (CKEC), the small-city specialist, which pays no dividend but has the brightest growth prospects of the three.
Don't call the box-office surge a comeback. "For years I've been fighting this perception that movie theaters are dying," says David Brain, chief executive of EPR Properties (EPR), a real-estate investment trust that leases buildings to theater owners. "The reality is the industry is a steady 3%-to-4% grower."
Boom years like 2012 are usually the result of a confluence of hit films. The Avengers, The Dark Knight Rises, and Hunger Games brought in a combined $1.5 billion. Hollywood has gotten better at turning out dependable hits by relying on sequels, prequels, and spinoffs—or any excuse to bring back franchise characters, especially comic-book heroes. Last year, seven of the top 10 movies were sequels, according to Box Office Mojo, an industry tracker. This year, there are 27 franchise films on tap, including sequels to Hunger Games, Thor, and Iron Man.
The theater industry has also gotten more efficient. There are fewer cinemas but more screens, smaller auditoriums but higher ticket prices. Digital distribution of films allows cinemas to react quickly to demand, playing a hit on several screens and staggering start times by 30 minutes, so that "sold out" means wait a bit, not come back another day. Another upside of the new digital gear, says Carmike chief executive David Passman, is that it allows theaters to show live events, like fights, operas, sermons, and concerts.
Of course, moviegoers can get all of these things and more at home. But as Hollywood likes to say, people who have kitchens still go out to eat. "Home entertainment competes with other things you can do at home; movies compete with other things you do outside of the house," says Patrick Corcoran, research director at the National Association of Theater Owners.
The public's dour view of the theater business has left stock valuations for cinema companies reasonable. Regal, with nearly 7,000 screens, goes for 15 times projected (pardon the pun) 2013 earnings, but it's only nine times free cash flow. The latter is the more important measure because cash pays the company's dividend. Up 16% over the last year, Regal's shares should continue to grow, albeit at a slower pace. Revenue is expected to rise 3% this year and 2% next year.
Cinemark, up 46% in the past year, is growing more than twice as fast as Regal. Nearly 1,300 of its 5,200 screens are in Latin America; it's the No. 1 operator in Brazil, Argentina, and Chile. All are thriving markets. From 2007 through 2011, box-office receipts in Latin America grew by 17% a year, compounded. Shares go for 15 times 2013 earnings and a similar multiple of free cash flow.
Carmike is the smallest of the bigs, with 2,200 screens. Since signing on as chief executive in 2009, Passman has closed underperforming theaters, upgraded others, cut costs, and driven concession sales higher. Yearly losses have given way to fast-growing profits, and shares have soared 127% over the past year. They're still inexpensive, at 13 times the 2013 earnings forecast and less than 10 times 2014. With per-theater results improved, Passman says he's shifting into fast-growth mode to reach 3,000 screens, at which point the company will decide whether to go bigger or begin returning cash to shareholders—or both.
The key to Carmike's growth is its focus on small cities with limited competition, including Allentown, Pa.; Athens, Ga.; and Chattanooga, Tenn. Half of the nation's 40,000 movie screens are owned by the four largest companies: these three plus AMC Theaters, which was sold last year to a Chinese conglomerate. The other half belong to smaller players, many of which lack the scale to negotiate with studios for a healthy cut of revenues. More important, they lack the money to upgrade to modern digital equipment, even though reels will soon go the way of VHS tapes. Carmike is a natural buyer for these smaller outfits.
Barrington Research added Carmike to its list of top stock picks for 2013. Jim Goss, who covers the movie business for Barrington, expects the stock to be more volatile than the others but says it could hit $25 in a year, up from $15 and change now.
The real-estate investment trust EPR is another good option. It sells for 12 times estimated 2013 funds from operations, a key metric in commercial real estate, and it pays a 6.5% dividend. Both numbers compare favorably with other REITs. EPR's portfolio is about two-thirds theaters; the rest includes charter schools and golf and ski properties. One underappreciated opportunity for theaters, says EPR's Brain, is a small but thriving base of premium auditoriums with comfier seats, gourmet food, and cocktails. "I call it 'bringing back the boomers,' " he says, estimating that high-end auditoriums could one day make up 15% of the market. If he's right, EPR will get a cut of rising concession revenues for all that whiskey and coconut shrimp.