It was therefore with great interest that I noted a significant investment in Cineworld (CINE: 336p) by the cinema operator's chief executive and deputy chief executive Moshe and Israel Greidinger. In fact, through their 54.8 per cent shareholding in Global City Holdings, a company that is listed on the Warsaw Stock Exchange, the directors have backed the purchase of 2.15m Cineworld's shares at 309.3p each on Friday 17 October. This lifted Global City's stake in Cineworld to 29 per cent. It wasn't an isolated transaction either as at the start of this month Global City acquired 3.6m shares at prices between 318.7p and 325.6p at a cost of £11.6m.
Moreover, having gone through every single director transaction since late February when Cineworld combined its cinema operations with Cinema Cinema International (CCI) in a £500m deal and one that resulted in Global City owning 24.9 per cent of Cineworld's equity, it is apparent that the stakebuilding has been pretty concerted. In fact, Global City has raised its stake from 65.5m shares when the Cineworld deal completed to 76.6m at the time of the latest disclosure. Between the end of May and 20 June alone, Global City acquired 4.45m shares at a cost of £15.2m, or an average buy-in price of 341p each. By my reckoning this eight-month buying spree has cost Global City well over £36m at an average buy-in price of around 330p on its 11.1m shares.
It's worth flagging up too that the 65.6m Cineworld's shares issued to Global City when the takeover completed were issued at 353p each. Therefore, this is a rare case where outside investors have the opportunity to buy in on the same terms as the insiders. Importantly, the technical and fundamental investment cases are both supportive.
A positive chart set-up
Having hit an all-time high of 403p in January, Cineworld shares have been consolidating the gains made over the past few years. Bearing this in mind, it's worth noting that having bottomed out at just below 300p in mid-April, the share price appears to have made a successful retest of that low 11 days ago when the price briefly skirted with the 300p level before buyers came in and pushed the price up around 10 per cent. From my lens at least this looks like a potential low is in place and an attempt on the 355p summer highs could be on the cards. If that price point is taken out then this would shorten the odds markedly of a run-up to January's record high.
The technical set-up for a chart break-out certainly look positive: the moving average convergence momentum oscillator is positive and above its signal line; the share price has regained territory above both the 50-day and 200-day moving averages (in the range 325p to 300p), but is not overextended above these trend lines; and the 14-day relative strength indicator has a reading in the mid-60s, so is not overly overbought, thus offering scope for a break-out to occur above the 355p key price level. But for that to happen we need more than just a favourable technical set-up and heavy director buying. We also need a strong fundamental case to drive a rerating. And that's exactly what's on offer here.
CCI to boost Cineworld's growth
The acquisition of CCI was an important deal for Cineworld as it created the second largest cinema business in Europe with over 1,850 screens across 201 sites. CCI operates around half of these in seven countries in Eastern Europe and Israel including Poland, Hungary, Czech Republic, Romania, Bulgaria and Slovakia.
The business was formed by Moshe and Israel's grandfather in Israel over 80 years ago, but it is only in recent years that it has been growing quickly, having doubled the number of screens in the eight years since the company's IPO on the Warsaw Stock Exchange. CCI has a clear expansion strategy too as 36 new multiplexes are currently under development which will add an additional 377 screens. It's also a highly profitable operation as cash profits have been growing at an annual rate of almost 19 per cent in recent years. This expansion strategy should also help boost Cineworld's earnings growth rate, something that has been lacking this year due to the short-term headwinds the business has been facing.
In fact, EPS are forecast to be flat at 20p in the 2014 fiscal year. This partly reflects the impact on EPS from a rights issue in February which resulted in the issue of 48m new shares to raise £110m in order to part fund the cash consideration of the CCI acquisition. The company also issued 65.6m new shares to the owners of CCI with the balance of the cash consideration satisfied through a debt facility of £162m. But the lack of earnings growth also reflects the combination of hot weather and the distraction of the FIFA Wold Cup. This meant that trading over the summer was more subdued than normal - admissions at the Cineworld chain in the UK were down 3 per cent in the six months to end June 2014.
Still, the business is outperforming peers as UK box office revenues only declined by 0.5 per cent in the first half against a market down 5.7 per cent. Cineworld's unlimited cinema pass continues to gain traction while initiatives such as allocated seating for cinema goers have proved popular. Last year's acquisition of the 21 Picturehouse cinemas is clearly delivering.
Expect strong earnings growth in 2015
Importantly, with the benefits of the CCI deal set to flow through in 2015, and cinema admissions expected to be up on the back of a number of blockbusters slated for release in 2015, then I feel investors will start to warm to Cineworld's revitalised earnings growth story. Not only is the new James Bond movie Bond 24 earmarked for release in 2015, but so is the eagerly awaited Star Wars: Episode VII. These films should pull in the customers and give Cineworld's and CCI's sales and profits a material uplift.
According to analysts at brokerage N+1 Singer, CCI should be capable of contributing revenues of £291m and operating profit of £35m in 2015 when the benefits of the cost savings and synergies from the combination of the two businesses will be seen. Cineworld has already achieved its initial target of £2m worth of annual savings and is aiming to make annualised savings of £5m by 2016. For the current financial year to the end of December 2014, N+1 Singer have factored in operating profit of £20m on revenues of £202m from CCI which reflects a nine month contribution.
The combined group forecast is for Cineworld to report pre-tax profits of £62m on revenues of £630m this year, rising to £86m and £763m, respectively, in 2015. On this basis, expect adjusted EPS to rise 30 per cent to 26.2p in 2015 and the PE ratio to fall from 17 to 13. Analyst Sahill Shan at N+1 Singer also expect EPS to grow by 12 per cent to 29.2p in fiscal 2016. These forecasts seem realistic as they factor in the addition of 305 new CCI screens and 169 Cineworld screens between 2014 and 2016. A more diversified geographic spread to mitigate volatility of earnings from any one country and an accelerated roll-out of new sites can only add to the attraction.
Prospect of improved shareholder returns
I also feel that investors will start to warm to the prospect of an improvement in shareholder returns. Based on N+1 Singer's estimates for the full year I anticipate a current year return on equity (RoE) of just under 10 per cent. This reflects the fact that shareholder funds have risen by 150 per cent to £500m following the equity issues in February. But if the company can deliver the aforementioned profit forecast for fiscal 2015 then expect RoE to increase to around 12.5 per cent.
Moreover, with the group carrying net debt of around £317m on its balance sheet, this means that its return on capital employed (RoCE) will start to narrow the gap with its weighted average cost of capital (WACC). The aim is for the RoCE to be above the WACC by 2016.
In the meantime, shareholders can expect another 0.5p hike in the payout per share to 10.6p this year and 11.1p in 2015, implying prospective dividend yields of 3.1 per cent and 3.3 per cent.
Risk warnings
Clearly, there are risks to any investment no matter how attractive the investment case. For starters, there is execution risk as 58 per cent of Cineworld's revenues and 62 per cent of its profits this year are second half weighted. There is execution risk next year too in order to generate the annualised savings that are factored into earnings estimates from combining the two businesses.
It's worth noting too that the company reintroduced its 50p booking fee for both telephone and online ticket purchases having created a database of 3.5m MyCineworld online customers and attracted 372,000 purchasing an unlimited pass. The level of attrition is the great unknown, although if there is no attrition at all then analysts' estimate a 4 to 6 per cent uplift to annualised profits.
The political and economic environment also pose potential threats to the business as it is clear that there has been a marked slowdown in certain parts of the eurozone even if the UK economy continues to outperform the region.
And of course there is no guarantee that the blockbusters next year will not flop at the box office. That said with five slated for release this mitigates the risk.
Target price
So having taken all the above factors into consideration I feel that the share buying by the chief executives company Global City is fully justified and likely to prove rewarding to follow. My view is that fair value for Cineworld's equity is around 400p share, or the equivalent of 15 times 2015 earnings estimates, falling to 13.7 times 2016 estimates. This target also neatly coincides with the January all-time high.
My time frame to achieve this target is six months which encompasses the release of a third quarter trading update next month, a pre-close update in January and the full-year results in March. Trading on a bid-offer spread of 336.2p to 336.7p, I rate Cineworld shares a buy.
Please note that I have written 20 other columns in the past fortnight including two yesterday, all of which are available on my IC homepage...
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
