Cube Midcap Report (28 May 2020) – Cineworld hopes for a blockbuster

Cube Midcap Report (28 May 2020) – Cineworld hopes for a blockbuster

Good morning, it’s Roland here with today’s Midcap report.

There’s an interesting mix of news this morning, including certainty for Boohoo shareholders and a debt update that’s given Cineworld’s share price a big lift.

As always, midcap requests in the comments are welcome — here are the stocks on my to-do list at the moment:

  • Cineworld (CINE)
  • Boohoo (BOO)
  • easyJet (EZJ)
  • Paypoint (PAY)
  • Daily Mail and General Trust (DMGT)
  • Stagecoach/First Group

This report is now finished (12.00).


Cineworld

  • Stock data should display here.
Market cap £1.2bn
RNS Covenant amendements & extra liquidity secured
Writer disclosure No position

The Cineworld share price is up by 30% as I write this morning. Although there is some positive news in today’s update, on balance I feel that once again, shareholders may be a little too optimistic.

Let’s take a quick look at the facts, before considering the possible implications on Cineworld’s financial position.

New lending & covenant amendments

Liquidity: Cineworld believes it can secure a total of $180m of additional liquidity, from three separate funding sources:

  • The group’s existing $462.5m revolving credit facility (RCF) has been extended by a further $110m
  • Cineworld has credit committee approval to apply for an extra $45 through the UK government CLBILS scheme
  • The company is also planning to apply for $25m of funding through the US government CARES Act

Although the $70m of government funding has not yet been confirmed, I think we can assume it will be approved.

The company is now confident it has enough headroom, even if cinemas remain closed to the end of 2020. I agree with management that this seems unlikely — reopening in July appears to be the most likely scenario at present.

Covenants: The main change announced today is that the leverage covenant test on Cineworld’s RCF has been waived for June 2020 and will be increased to 9x net debt/EBITDA for the December 2020 test. This covenant was previously set at 5.5x net debt/EBITDA and will return to this level in June 2021.

EBITDA will have collapsed as a result of the closure of Cineworld’s cinemas for more than two months. So this change isn’t surprising and doesn’t necessarily indicate that debt levels have rocketed.

How much liquidity does Cineworld have?

In my view, management have been a little vague about the group’s debt levels and available liquidity in recent statements.

As far as I can see, Cineworld has not made any disclosure of its RCF utilisation or total available liquidity beyond its 31 December 2019 accounts. Nor has there been any detail on the rate of cash outflows while cinemas are closed. This is a contrast to many other similar-sized firms, which have provided all of this information in recent RNS statements.

What do we know? The going concern statement in the 2019 accounts included the following comment:

Under the specific downside scenario, however, of the Group losing the equivalent of between two and three months’ total revenue across the entire estate there is a risk of breaching the Group’s financial covenants, unless a waiver agreement is reached with the required majority of lenders within the going concern period.

We now know that cinemas will have been closed for over two months, resulting in a total loss of revenue during this time. So without today’s covenant waiver, I think we can assume Cineworld would have breached the terms of its credit facilities if they’d been tested at the end of June.

RCF utilisation: At the end of 2019, Cineworld said it had drawn $95m from its $462.5m RCF (essentially an overdraft). This facility has now been extended to $572.5m and June’s covenant test has been waived.

However, covenant testing is only triggered when utilisation of the RCF rises above 35%. From this, I think we can assume that the RCF will be more than 35% drawn by the end of June. My sums suggest that at least $200m will have been drawn down at that time, leaving a maximum of $372.5m available. Although this figure could be significantly lower, depending on current utilisation. We don’t know.

In addition to this, the company hopes shortly to secure access to $70m of UK and US government funding.

So in total, I estimate Cineworld’s maximum liquidity could be $442.5m at the end of June. But again, this figure could be much lower.

By way of contrast, the group reported administrative costs of $902m last year, in addition to interest costs of $165m. Taken together, these averaged c.$89m per month.

I expect that many of these costs will have been reduced through furloughing staff, rent relief and so on. But as Cineworld hasn’t told us, we don’t know what the current rate of cash burn might be.

My view

It’s hard to form a definitive view on Cineworld’s financial position, as we don’t know how much liquidity it has or the current rate of cash burn. All we know is that the group expects to be able to survive closure until the end of 2020 — a scenario I think is unlikely.

In a bullish scenario, where cinemas reopen and quickly return to normal levels of profitability, Cineworld shares could be cheap at current levels. I estimate that the group generated free cash flow from operations of $515m last year, after servicing its debt and lease obligations. At current levels, the stock is valued at just 1.5x this free cash flow figure.

However, I don’t know how quickly cinemas will be able to return to normal. One possibility I can see is that like airlines, they may face a choice between social distancing (low seat occupancy) or a ban on food and drink sales (so that customers can wear masks). Either option would hit margins.

What really tips me into the bear camp is the ongoing acquisition of Canadian chain Cineplex. There was no mention of this today, but Cineworld was originally planning to borrow another $2.4bn to fund this takeover. I think the Cineplex deal should be canned, but it was voted through in February and management appear intent on completing it if possible.

On balance, my view is that Cineworld has too much debt and is likely to need refinancing at some point. If this happens, shareholders could face significant dilution.

It’s worth noting that the value of the group’s equity is currently £1.2bn, but its enterprise value is c.£7.5bn. Bank debt and lease obligations totaled nearly $8bn at the end of 2019.

I wouldn’t want to be long or short here.


Boohoo

  • Stock data should display here.
Market cap £4.7bn
RNS Acquisition of remaining 34% stake in PLT
Writer disclosure No position

Graham covered the bear attack on Boohoo in yesterday’s report, so I won’t recap this here.

The allegations in the report centred around the group’s part-owned subsidiary, PrettyLittleThing, and the accounting treatment of this business.

Boohoo issued a rebuttal statement yesterday and has now put this story to bed in the most sensible way, by acquiring the remaining 34% of PLT it doesn’t already own. Boohoo will pay £162m in cash and up to £162m in stock, subject to various conditions.

The Boohoo share price is up sharply, as shareholders welcome the full acquisition of the group’s most profitable brand.

The valuation of this deal looks fairly reasonable to me. With so much scrutiny on the firm, an excessive valuation was less of a risk — so perhaps the short attack achieved some of its goals, after all.

If I was being pendantic, I’d say that it looks like the company is using the cash it raised in a £200m placing recently to fund this deal. But to be honest, I think it’s irrelevant. Boohoo is cash generative and already had net cash before the deal. The placing cash was to fund growth opportunities — so far, PLT has proved to be one of the best such opportunities.

If I was a Boohoo shareholder, I’d be very happy with today’s news.

Incidentally, I reckon that the management of AIM compatriot and fellow short target Burford Capital could learn a few things from Boohoo’s approach to this situation.


easyJet

  • Stock data should display here.
Market cap £2.9bn
RNS Update on fleet capacity and cost structure
Writer disclosure No position

Another quick update. The easyJet share price is higher this morning after the company unveiled plans to cut its workforce by up to 30%.

Management share the view of the IATA that passenger numbers are unlikely to return to 2019 levels until 2023. To reflect this, easyJet plans to reduce its fleet to 302 aircraft by the end of 2021. This is 51 fewer than previously expected — a reduction of 15%.

In percentage terms, we can see that planned job cuts are double the size of the expected fleet reduction. This tells me that boss Johan Lundgren is following Churchill’s advice to never waste a good crisis. The job cuts will also reflect the optimisation of our network and bases, improved productivity as well as the promotion of more efficient ways of working.

It looks like Mr Lundgren is  hoping to improve easyJet’s margins, which have always been lower than those of rival Ryanair. Let’s hope service doesn’t suffer too much — easyJet has always been better-liked than Ryanair!

Finally, in a nod to founder and major shareholder Stelios, the airline says that its “fleet deal with Airbus gives easyJet the flexibility to react to … varying demand environments”. Looks like management want to head off any further criticism from Stelios about their previously-planned fleet expansion.

My view

Although I don’t generally invest in airlines, my view of this business remains broadly positive.

However, easyJet’s share price has risen by 50% over the last two weeks. I think the stock is probably up with events at current levels.


Paypoint

  • Stock data should display here.
Market cap £507m
RNS Full-year results
Writer disclosure Long

Time is running out, but I’d like to take a quick look at payment processing firm PayPoint, which is a mid-sized holding in my own portfolio. I last covered this retail-focused company back in January, when I discussed its service offerings in more detail.

The full-year results today cover the period to 31 March 2020, so the impact of COVID-19 is minimal. The figures look pretty positive, in my view:

PAY FY20 highlights

However, the impact of COVID-19 on some popular services has been significant:

PAY COVID-19 impact

There are some signs of hope. The right-hand column provides the most recent data and shows that bill payments, ATM transactions and parcel traffic are moving back towards more normal levels as lockdown eases. However, they are still depressed.

The company says it’s not yet clear how much of the change will be structural, and how much will reverse. I think this is a fair comment at this time.

Dividend: PayPoint is not participating in any government support programmes and has not furloughed any staff. So this fabulously cash-generative company is still able to make dividend payments. A final dividend of 15.6p per share has been declared, representing a 34% reduction from the equivalent payout last year.

Future dividends will be calculated to support continued investment in the business and will target earnings cover of 1.2x – 1.5x earnings, subject to maintaining a strong balance sheet. That all sounds fine to me.

My view

Last year’s results highlight PayPoint’s profitability. The group’s underlying operating margin was 47% and my sums suggest a return on capital employed of 145%. When combined with a balance sheet that’s largely free of debt, these metrics make for fantastic cash generation.

The risk is that we don’t yet know whether the company will be able to return to this happy state of affairs as the pandemic recedes. However, my view is that the firm should be able to adapt to the decline of cash by becoming the de facto payment services provider for convenience stores and perhaps other retailers.

PayPoint currently has a UK network of 26,800 stores out of a total addressable market of 62,600. I believe this network will continue to have value and am happy to allow newly-confirmed chief executive Nick Wiles to navigate this changing market.

At current levels, I’d guess that the company could offer a dividend yield of 4%-5% going forwards. I think this is could be an attractive entry point and remain happy to hold.


That’s all I’ve got time for today, sorry I didn’t get to DMGT or Stagecoach.

Thanks for your time and support. As always, any comments or likes/dislikes are much appreciated, as they really help us to shape our midcap coverage here at Cube.

Regards,

Roland

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    To readers – thanks for liking Roland’s articles (and everyone else’s articles) – great to know you’ve got something out of it! G

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    Thanks Roland.  I was a CINE holder despite the debt.  I ran out of faith significantly down when I realised that ultimately I didn’t trust management due to a mix of transactions I couldn’t fathom, lack of overall transparency and poor expectation setting.  I have faith in the cinema business for the long term, despite it having some challenges, I just don’t trust their management.

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