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Secular vs. Cyclical
Turnaround investors analyzing a downtrodden stock often face the following question: is the company’s problem cyclical or secular? Cyclical means that the company (or its whole industry) is facing temporary headwinds that are likely to swing back eventually to a more favorable direction. For example, auto makers and airlines tend to do poorly when the overall economy weakens but then rebound when the economy strengthens again. Secular means that the negative forces affecting a company are long-term and often permanent in nature. For instance, many people believe that the changes to the retail sector brought about by Internet shopping are not likely to reverse and therefore should be considered secular.
The movie theater industry presents a very timely example of the cyclical versus secular dilemma. The stocks of the theater operators have been among the worst performers this year. While the broad market has gained nearly 13%, many stocks in the theater industry have declined by 20-50%. Are the problems secular or cyclical? The right diagnosis could mean a huge difference in stock profit returns.
A major secular issue is the rising use of streaming services like Netflix and Amazon Prime that let viewers watch movies anytime and anywhere. These services won’t be going away and if anything are likely to increase—making this a secular issue.
The theater industry is also in a cyclical downturn. Since 2009, the industry has had two cyclical downturns, each lasting a year or two, with ticket volume declines of roughly 7-10%. Attendance this year could be down 10% or more. These downturns have been largely attributed to a spate of weak offerings from the movie producers or a temporary shift in entertainment preferences. If the current weak attendance is mostly cyclical, it will likely reverse and produce impressive gains for investors as theater profits rebound.
Although we respect the longer-term secular issues, we think much of the recent problem is cyclical, largely driven by ebbs and flows in movie quality. Through the end of the summer, this year’s movie line-up has been mostly lackluster. Nevertheless, viewers are still enthusiastic about seeing great movies at the theater. The “experience” of going out to see a movie has been drawing people to the theaters for more than a century, and we don’t see that changing soon. Moreover, theater operators are working hard to enhance the movie-going experience with luxury recliners, improved food offerings, alcoholic beverages and other amenities.
The slate of movies for the rest of this year looks promising with a new Star Wars film, three superhero movies and a new edition of the successful Planet of the Apes series. Two recent releases support our thesis that people still enjoy going to the movie theater. Stephen King’s It has been a surprise success, grossing $270 million worldwide in only three weeks to become the #1 horror movie of all time, and Beauty and the Beast grossed $1.3 billion.
Current cinema stock valuations reflect investors’ low expectations. Most of our selections trade for less than 8x next year’s expected EBITDA and yprovide generous dividend yields. Compare these to competitors Netflix, selling at 46x EBITDA, and Amazon, selling at 18x EBITDA, with neither offering a dividend. From our seat, the theaters look like more entertaining value. Learn more six movie theater stocks ripe for a turnaround.