With the current state of the markets there isn’t a lot that I would exactly be rushing to buy at the moment, as I think that even the good companies that have strong enough balance sheets to survive relatively unscathed, could well go a fair bit lower yet. The markets have just had a big bounce back and at one point were up nearly 20% on their recent lows, as huge stimulus and bail out packages have been announced by governments, including in the UK and US. But I am far from convinced that these rises will last and think that we could well just be seeing the typical relief rally that you get on the way down – often before a big drop. Reading the likes of Twitter and the comments from many private investors anyone would think that we are already back in a bull market, and it appears that some are piling back into equities already. But what I think many are missing is the lasting economic impact that this virus is going to have, with predictions for massive reductions in GDP for at least the next two quarters, maybe longer, and rapidly rising unemployment in some countries, such as the US.
None of that suggests to me that the economy is going to get back to normal quickly, and the impact of the huge amounts of borrowing by governments could be felt for many years to come – the US is about to announce a $6 trillion package, and to put that into context, its total GDP for 2019 was $21.427 trillion, so that equates to close to 30% of GDP, and likely a much higher percentage when compared to the GDP figure recorded for 2020. Based on all of this, and assuming that things don’t return to normal for many months – certainly in terms of continued social distancing and restrictions, I’ve been looking at companies which are going to be hit hard by this, and which also have levels of debt which suggest that they could get themselves into a lot of trouble very quickly – even allowing for potential help from the government in the form of loans. Cineworld (CINE) is one that has really got my attention - I know that it is also a company that Tom Winnifrith and Chris Bailey have been bearish on - especially now that its shares have bounced back up to around the 62p level and a market cap in excess of £850 million, having hit a low of just 18p on March 17. Given the impact on its 790 sites spanning 11 countries, many of which are having serious outbreaks of Covid-19, it is hard not to see this as a nailed on short from this level.
When it comes to potential bail-outs, a cinema business isn’t exactly going to be at the top of the governments list of sectors to help, and although it should benefit from reduced staff costs under the government scheme to contribute towards wages, I’m not convinced that will come anywhere close to offsetting the damage that will be done by a prolonged ban in many countries of engaging in activities such as going to the cinema. If we look at the recently released preliminary results for 2019, the company managed to make an operating profit of nearly $725 million, allowing for the impact of the adjustments made as a result of the adoption of the IFRS 16 adjustments, and that resulted in a net profit of $180 million, which was already significantly lower than 2018, as a result of the introduction of the new accounting practices – it would have been $65 million higher than the previous year, without the adjustment. What really stands out to me though is the magnitude of the finance costs which had increased to $568 million for 2018, and although $304 million of that is as a result of IFRS16 changes to the way in which lease liability interest is recognised, it is still significantly higher than the $225 million for 2018, and something which I see as being a potential problem for the company as revenue for 2020 plummets. And that of course is aside from the debt itself which that relates to, and at the end of last year consisted of $3.4 billion of US term loans, a $215 million Euro loan, and $95 million drawn on a revolving credit facility. It does still have some room on that facility, which totalled $462 million, but I also suspect that some covenants are in place relating to debt and which could cause the company issues if its EBITDA plummets and those covenants aren’t relaxed. Plus it had $140 million in the bank as well. But even at the end of 2019 its balance sheet didn’t exactly look in great shape, even allowing for the impact of the accounting adjustments, as it had net current liabilities of circa $1.05 billion!
The company had been planning to acquire Cineplex for $2.1 billion, and it is probably lucky that deal hadn’t already completed prior to this virus coming along. For a company that already looked weak financially even prior to the Covid-19 outbreak, it could prove to be fatal and I can certainly see the share price going a lot lower. There is of course always a slim chance that another player could be interested in acquiring it at a knock-down price, but I see that as extremely unlikely in the current climate, and with anyone in this sector also suffering a big downturn and looking to preserve cash. So for me, it looks like a very good shorting opportunity from the current share price level, especially given that it has seen a sizeable bounce in recent days.
Filed under: Cineworld, Gary Newman, BigDish, Zak Mir, Intu, Breedon, OptiBiotix, Tern
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