By: Jeff Pollock
August 4, 2017
It goes without saying that the price of a stock always differs from its intrinsic value. As the stewards of private client savings, our job is to find undervalued securities that trade at a discount to what they’re worth.
Columbia Professor and investor Benjamin Graham introduced in his 1948 publication “The Intelligent Investor” a fictitious trader named Mr. Market. As Graham described, Mr. Market’s decisions are driven entirely by emotion and disregard any sort of fundamental analysis. He’s subject to panic and overreaction just as much as he is to euphoria and irrational exuberance. Each day between 9:30am and 4:00pm, we buy or sell stocks with Mr. Market when his better judgement is blindsided by emotion.
Cineplex reported quarterly earnings Wednesday morning that fell short of expectations. Though attendance in its theatres was expected to grow by almost 5%, it declined by 2%. The stock subsequently slid as much as 16% moments after the opening bell to $41.50. By the end of the day, it had erased half of its early morning losses and closed at $45.43, an 8% decline nevertheless for the day.
A closer look beneath the headlines leaves one to conclude that yesterday’s selloff was an obvious overreaction by Mr. Market. Analysts projected stronger attendance growth because the Canadian industry grew 6%. However, two reasons can account for the lackluster performance. First, Bon Cop, Bad Cop 2 posted exceptional results in Quebec. However, while Cineplex commands a 70% market share in Canada, its presence in Quebec is meagre. Second, 33 theatres went dark to retrofit its space to install recliners. This initiative will continue into the third quarter and pay off handsomely when the new Star Wars film is released later this year.
Ignored from yesterday’s report was the progress that Cineplex continues to make in diversifying its revenue. In 2013, 59 percent of the company’s revenues were generated from movie ticket sales. Today, it’s dropped down to 47 percent. Over the same horizon, Amusement revenues have increased from 1 percent to 13 percent. As more of The Rec Room venues continue to open (there’s one in Toronto near the Rogers Centre and another in South Edmonton), Cineplex will further diversify its business model away from a movie theatre company towards an entertainment business. So far, the two open venues have exceeded management’s expectations. In 2017, two more will launch in Calgary and Edmonton. In 2018 and 2019, another three will open in London, Burnaby, and Mississauga.
Beyond its growth ventures, Cineplex continues to demonstrate its ability to raise prices. “Box office revenues per patron” (or, the average ticket price) rose to $10.36 this past quarter, an increase of 4.8% year-over-year, while the “Concession revenues per patron” increased to $6.03, a 5.1% increase year-over-year.
Amid the selloff since Cineplex reported earnings, Mr. Market overreacted by dumping the stock due to one lousy quarter. What he disregarded was the long-term growth potential that this company offers as it enters the ever-popular and increasingly growing gaming segment. We viewed this as an opportunity to purchase shares for clients. While quarterly earnings are valuable for an update, the long-term strategy of a business are far more important when making an investment than one quarterly earnings miss.
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