Sage Investment Club

Scott OlsonMovie theater chain Cinemark Holdings’ (NYSE:CNK) stock has plunged over the last year as theater attendance never returned to their pre-Covid levels and investors began worrying about potential financial problems in 2-3 years when a significant amount of debt will have to be refinanced. Total industry domestic box-office revenue was down 35% in 2022 from pre-Covid 2019. The reality is there is too much theater capacity in the U.S. compared to expected continued decline in attendance as competition from streaming services keeps people at home watching on their big screen TVs sitting in comfortable chairs. Movie Theater Industry Continues to Struggle The entire movie theater industry had a very difficult year in 2022. After a terrible 2020 and a partial turnaround in 2021 many bullish investors expected a robust 2022 but were greatly disappointed. Cineworld Group (OTCPK:CNNWQ), which owns Regal Cinemas, filed for Ch.11 bankruptcy on September 7. AMC Entertainment (AMC) is trying to be creative in restructuring their distressed balance as their stock price plunges. On a relative basis Cinemark has performed better than the rest of the industry, but on an absolute basis it had a poor year just as I expected. I recommended selling CHK in my January 2022 article and the stock price has dropped about 50% since that sell article was published. Data by YChartsThe headlines proclaiming blockbuster box-office results for Avatar: The Way of Water got movie theater investors all exited, but you can’t ignore the many other months when attendance was poor, especially on weekdays. As the table below by Box Office Mojo for domestic box-office gross revenue shows 2022 was still way below pre-Covid numbers. The table also shows a continued low level of releases partially because production was halted during the pandemic. I have doubts that the movie theater release numbers in the future will be as high as some bullish investors are hoping. Movies might be made, in my opinion, but not released via traditional movie theaters. The industry has changed, and it is not going back to the pre-Covid business model. Annual Gross Revenue, Releases, and Average Revenue Per Release With soaring inflation last year many families had to be frugal when budgeting for entertainment expenses. Taking the family to a movie is not cheap, especially factoring in food/drink items at the concession stand. It is much cheaper just to stay home and pay for some movie on a TV. Inflation had a major negative impact on 2022 theater attendance, in my opinion. Even if inflation is modest in 2023, the mere threat of a recession will most likely mean families will remain cautious with non-essential expenditures, which will hurt attendance. Speaking of inflation, it is a little odd that Cinemark’s average U.S. ticket price in 3Q 2022 was actually down 3.6% from the same period in 2021 to $8.75 from $9.08. Concession revenue per patron was up 2.7% to $6.81 from $6.63. With inflation well over 8% one would have expected much higher figures for both metrics. These metrics I think reflect fairly weak customer demand for their services/products. National Cinema Day that offered discount tickets and discounts at the concession stands could have impacted these numbers slightly. There are two major problems, in my opinion, for current movies. Too many are just sequels. Hollywood seems to be struggling to come up with new exciting/interesting movies that are “must see” movies. The second problem is that Hollywood has become way too woke for much of the “fly over” part of the country. Disney’s (DIS) Strange World was a total disaster when it was released last November, for example. It seems that too many movie producers are pandering to liberal media movie critics and not to actual paying customers. Movie theater owners want people in their theater seats (also at their concession stands) and not just having the words “critically acclaimed” on their marquee signs. Too Much Debt Not only does Cinemark have a lot of debt, but that debt could get very expensive to refinance in the future as interest rates soar, especially for low quality paper. They have $2.4735 billion in debt, which is about $20.53 debt per CHK share, which compares to a current stock price of $8.42. There is also about $4.78 million average debt per theater and that does not even factor in lease liabilities. In addition, they carry $1.249 billion goodwill on their balance sheet or about $10.37 per share. There is always the risk that there could be some future impairment charges that could result in the value of that goodwill being written down. Total Long-Term Debt as of September 30, 2022 sec.govCinemark is facing the same problem that many other companies that have low debt ratings are facing and that is soaring interest rates. Cinemark unsecured notes are rated B by S&P. The effective average yield on B rated debt rose an astounding 400 basis points in 2022. With further Fed tightening this year and as the economy drops into a recession potentially reducing the quality of the paper, I would not be surprised to see B rated debt hitting 10.5% in 2023 and into 2024. B Rated Effective Yield for Past Year fred.stlouisfed.orgCinemark’s 5.25% 7/15/28 unsecured notes were trading at 11.23% yield last Thursday, but the note price rose with the rest of the bond market on Friday. Their paper seems to be trading as a “weak” B because their 5.875% 3/15/26 unsecured notes were trading at 11.64% on Thursday. As 2023 rolls along, investors are even more likely to look at Cinemark’s debt maturities. Often companies do needed refinancing long before the actual debt issue matures. Cinemark’s management is going to be faced with a decision to refinance on a conservative/prudent refinancing timetable or wait to see if distressed interest rates drop before refinancing $250 million 8.75% secured notes that mature 5/1/25. Since it is secured debt, it should, in theory, be fairly easy to refinance. That is followed by $460 million convertible notes maturing 8/15/25. Since I don’t see any strong improvement in their operations over the next few years, the debt issue that I think could be most problematic is the $405 million 5.875% unsecured notes maturing 3/15/26. While 4Q might actually show a profit, the entire year results should still show a loss because for the first nine months they reported a loss of $1.43 per share. These continued and probable future losses make it much more difficult to refinance their debt. I don’t understand why they have not issued additional shares to raise cash that can be used to reduce their debt. The board, in my opinion, should sell new stock now and not wait until the stock price has dropped to where massive dilution results from selling at very low prices. Assume, for the sake of discussion, that Cinemark refinances all their debt at an average of 300 basis points higher than their current debt, which is a realistic assumption, their annual interest expense would increase almost $75 million – that is a lot of negative cash flow. They are going to be barely cash flow positive this year. If you combine future needed capital expenditures to upgrade/maintain their theaters and future higher interest expenses, you have a serious problem. Value of National CineMedia Investment Has Plunged Cinemark effectively owns 25.6% of National CineMedia (NCMI), which is a digital in-theater advertising company. The market value of that stock has dropped almost 90% over the last year. This is a paper loss of approximately $1.00 per CNK share and just adds to the list of other problems that Cinemark has faced over the past few years. Data by YChartsConclusion Cinemark has been hit by three major problems. Soaring inflation makes potential customers less likely to spend what cash they have, after paying for basic necessities, to take the family to the movies. Competition from streaming services continues to impact where people watch a movie. A 400 basis points increase in B rated debt raises concerns about future refinancing their very large debt outstanding. In 2023 I think a recession will impact people trying to decide where to watch movies, which will not be a positive for movie theaters. I also think interest rates for low quality paper will remain very high – if not higher in 2023. I rated Cinemark a sell in January 2022, and I continue to rate it a sell. While I am short CNK I would not recommend shorting it because of the potential for very irrational meme trading. I have deep enough pockets to meet margin calls, others may not.

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