Turnaround Letter Buy-rated AMC Entertainment (NYSE: AMC) reported mixed fourth quarter results although they were much stronger than investor expectations. Full-year 2018 results were more impressive, supported by a record year for industry-wide box office sales. After years of heavy capital spending and many acquisitions, the company will increasingly address investors’ demands to “show me the money” by generating more free cash flow. This could be a strong catalyst for the shares.
On February 28th, AMC reported mixed results for the fourth quarter, with revenues essentially flat and Adjusted EBITDA1 declining by 8% compared to a year ago. While the actual results weren’t particularly impressive, they were much stronger than investors were expecting.
Shares jump on the news
The better than expected profits drove the shares up 14% on the day. While the shares have trailed off since then to just above the pre-news price of $14, AMC shares remain up 18% year-to-date.
Attendance and food/beverage revenues increased but average ticket price fell
Adjusted for currency changes, fourth quarter revenues grew a modest 1%. Overall attendance increased by 2%. While the average ticket price fell 6%, it was partly offset by higher per-person spending on food and beverages (+3%), such that average total revenues per person fell only 3%.
About half the decline in average ticket prices was due to the effects of the growing roster of subscribers to AMC’s A-List program. For a monthly fee of $23.95, A-List subscribers can see up to 3 movies every week plus get discounts on food and beverage. The program now has over 700,000 subscribers, with its growth well-ahead of the company’s expectations. AMC commented that subscribers tend to buy more high-margin (often as high as 86% margin) food and beverages.
Fewer viewings at the more-expensive IMAX and 3D theaters also pulled down average ticket prices.
The Adjusted EBITDA decline was driven by weaker profits in the U.S, while profits in their International markets were up modestly. Weaker domestic profits were due to the initial costs of their A-List subscription service, fewer high-margin viewings at their IMAX and 3D theaters, and from the decline in profits due to their sale of their stake in National CineMedia business.
Clearer progress for full-year 2018
For all of 2018, the company’s progress is clearer. Revenues increased 8% and Adjusted EBITDA increased 13%.
In the U.S., Adjusted EBITDA increased by nearly 15% as attendance was strong, growing 6% compared to 2017. The company’s seat upgrade and other initiatives are producing good results. Industry-wide, domestic box office sales of $11.9 billion grew 7%, setting an all-time record high. The outlook for the 2019 industry looks favorable.
International revenues grew 7% and Adjusted EBITDA grew by 8%, although these were helped by acquisitions. Attendance fell due to a weak movie roster that competed with the mid-year FIFA World Cup, along with fewer theater upgrades and more competition. Higher average ticket prices and more food and beverage spending helped offset the weaker attendance.
Management’s focus is shifting to free cash flow – a potentially strong catalyst and now the key to the story
The company has been spending heavily to upgrade their theaters with patron-attracting recliners and other amenities. This effort appears to be approaching its completion in the U.S., as about 75% of its theaters are now upgraded. European theaters upgrades are ramping up and should be mostly completed in about a year.
For 2019 and beyond, the company will be increasingly shifting its focus toward increasing free cash flow and away from high capital spending. This shift could be a strong catalyst for the shares – investors generally are unimpressed with heavy capital spending as it drains cash away from repurchases and dividends, and often is misspent on poor returns projects with murky payoffs.
The focus on free cash flow will help the shares in two ways. First, it will highlight the company’s ability to actually generate sizeable free cash flow. While we believe the company’s spending has been worthwhile, its effect on profits is not entirely clear. The quote from the movie Jerry Maguire, “show me the money,” describes this situation accurately.
Second, the free cash flow will be used to reduce AMC’s sizeable debt balance, thus reducing the company’s financial risk. Lower debt means more value will accrete to shareholders.
Two ways that AMC can generate more free cash flow
The company can increase its free cash flow by generating higher EBITDA margins. In 2019, AMC’s A-List program should become a net profit generator, the seat upgrade initiatives should generate additional profits and their other initiatives look promising. In Europe, AMC’s renewed focus will likely bring higher margins there, as well.
The other driver of higher free cash flow is the company’s planned slowdown in its capital spending. While it spent $461 million in 2018 and expects to spend about $450 million in 2019, the company anticipates only $250 million to $300 million in capital spending afterwards.
The company will provide a more detailed investor update on March 19th.
The turnaround is headed in the right direction
AMC’s turnaround is headed in the right direction. The industry’s improved movie slate has provided it with a valuable tailwind as the company upgrades its theaters and develops its A-List program. Investor pressure to improve its margins and cash flow should help drive shareholder value over the next few years.
The key risks include a slow-down in attendance and continued weak average ticket prices. Its sizeable debt load remains a significant risk, as well as the temptation to make another large acquisition.
Relative to our $25 price target, AMC has met our end-of-scenario targets for its revenue and its EBITDA multiple. It still has to improve its EBITDA margin about 1.4 percentage points and reduce its debt by about $1.1 billion. We believe that with its increased focus on margins and free cash flow, and remain confident it its ability to reach our price target.
- Earnings before interest, taxes, depreciation and amortization, which is a measure of cash operating profits.
We continue to rate the shares of AMC Entertainment (AMC) a BUY with a $25 price target.
Disclosure Note: An employee of the Publisher owns AMC shares.