Description

Cinemark Holdings, Inc.  – compelling risk/reward investment opportunity                    

Investment Summary

Cinemark Holdings is the 3^rd largest movie theater chain in North America, operating over 500 theaters.

Cinemark’s stock is down meaningfully as the market has become increasingly concerned about the impact of the Hollywood actors’ and writers’ strikes on the box office in 2024. This past weekend highlights the current weakness (and perhaps is the bottom) as it was a very weak superbowl weekend box office.  We believe market participants are too short-term focused and that the combination of a return to box office growth in mid-3Q 2024, renewed focus on the blockbuster 2025 film slate, and the re-introduction of a dividend policy will drive a >50% return in the equity over the next 6 to 12 months with meaningful upside beyond that.

Business Overview

Cinemark is the 3^rd largest movie theater chain in the United States and by far the best operator, evidenced by the company’s industry-leading margins which are largely a function of management smartly choosing to operate in suburban geographies where cinema is core entertainment and where the company has lower rent relative to peers (their strong balance sheet has also enabled the company to negotiate favorable terms). The US represents ~80% of the company’s profitability with the remainder coming from Latin America (largely Brazil), where Cinemark holds even stronger leading positions in faster-growing markets. Management is excellent and insiders own over 10% of the stock.

We had chosen to avoid equity investments in the movie theater space for years (we owned the bonds) as streamers began to experiment with releasing movies on a direct-to-consumer basis. This paradigm has drastically shifted over the past 12 months, as these streamers have shifted their focus to profitability, resulting in cuts to streaming content spend and a renewed focus on theatrical releases which are far more lucrative and also perform better once they are eventually made available on streaming services.

Importantly, this trend extends beyond the big traditional studios to Apple, Amazon and Netflix. Apple has committed to spending ~$1bn per year on movies that will be released exclusively in theaters, while Amazon has stated that it plans to release 12-15 movies per year in theaters, equivalent to the release cadence of a traditional major studio. Even Netflix, once notoriously anti-theater, has begun to release certain titles in theaters.

Catalysts

Box Office Return to Growth in 3Q24

In the summer of 2023, the Hollywood writers and actors went on strike simultaneously for the first time since 1960. While there were hopes that these strikes could be resolved in short order, multi-year agreements with each union were not reached until November 2023. The extended length of the strikes has created a short-term supply shortage for movie theaters, as production shutdowns forced studios to delay movies scheduled to be released in 4Q 2023 and 2024. In 2024, the number of movies scheduled to be released on a nationwide basis is down to ~95, compared to ~110 in 2023 and ~130 p.a. prior to COVID.

The movies that were delayed were largely scheduled to come out in the first half of 2024, and include Snow White, Spider-Man: Beyond the Spider-Verse, Mission Impossible 8, and Captain America: Brave New World. We are confident that by July 2024 the box office will begin to inflect back to growth. This becomes particularly true in 4Q 2024 with the release of movies including Moana 2, Mufasa: The Lion King , and Joker: Folie à Deux.

Additionally, once the box office shows improvement, analyst focus will shift to 2025, featuring the strongest slate since 2019 with ~120 nationwide releases earmarked excluding the likely uplift from Amazon, Apple and Netflix. More importantly, the year is blockbuster heavy, including all the movies mentioned above in addition to 3 more Marvel movies, Avatar 3, Superman: Legacy and The Batman: Part II. While our estimates are roughly in-line with consensus on 2024 domestic box office at $8.3bn, we believe there’s upside to 2025 with the box office reaching $10.5bn compared to consensus at $9.9bn. As sell-side and buy-side analysts begin to set price targets based on 2025 numbers in 2H 2024, there will be a significant re-rating in the stock even on the basis of current consensus expectations.

Capital Return Restarts

Historically, Cinemark has been a dividend-paying company with a payout ratio in excess of 50%. The company cut its dividend during COVID to preserve liquidity and has clearly stated its intention to reinstate the dividend once the company is at a sustainable <3x net leverage level. The company reached that level in 3Q 2023, but given the uncertainty around the strike impact, management chose to delay the dividend until there is greater clarity on the outlook for the 2024 movie slate. 

We believe that now that the release schedule is known, the company will address a timeline for capital return on the upcoming quarterly earnings call. Overall, we project that the confirmation of the 2024 slate coupled with the strong outlook for 2025, will lead to a reinstatement of the dividend by late 2024. Based on our projections for 2025, the dividend yield at today’s share price would be near to 10%, far too high for a stable-to-growing business. In comparison, other stable dividend-paying companies have dividend yields closer to 3-5%, implying significant upside to the stock.

Outlook and Valuation

Cinemark currently trades at a ~16% FCF yield and ~5.1x EBITDA based on 2023 numbers. While we expect 2024 will be down in aggregate, the decline will be concentrated in the first half, setting up for strong growth in the back half and beyond. Even using full year 2024 numbers, the business still trades at a ~13% FCF yield and ~5.6x EBITDA, which make little sense considering the step function change in growth in 2025 and the more durable industry position post-streaming wars and post-strikes. Moreover, the company has more than $800 million cash on its balance sheet that is generating interest.

Using a ~10% FCF yield, which seems reasonable given the underlying quality of the business, we project that Cinemark is worth north of $25/share. For reference, prior to COVID, Cinemark traded at between 8-9x EBITDA on average (note that certain post-COVID multiples are not meaningful given negative profitability during 2020-2021). We use lower multiples given the higher rate environment, although we believe that the competitive dynamics (i.e. streaming and weaker theater competitors) have much improved.

We believe the strong cash generation of the business, the growth inflection in the second half of 2024, and the resumption of a dividend will drive a meaningful rerating in Cinemark’s stock and enable us to generate more than a 50% return over the next 6 to 12 months.

Catalyst

Box Office Return to Growth in H2 2024

Capital Return Restarts