My family saw Captain Marvel on the weekend. Blockbuster superhero movies torture me, but my son loves them and the cinema is easy, family-friendly entertainment.
There were few seats left and four tickets cost $80. After the popcorn, drinks and parking, the bill was $120. We could have watched another superhero movie at home via Stan or Netflix for under $1.
In spite of never-ending gloom, cinemas are still a great business when the content is right and some cinema-related stocks on the ASX and overseas exchanges offer value.
I know what you’re thinking: streaming services such as Netflix are an incredible threat to the movie business; as they produce more of their own movies and TV programs, available only through their streaming service, cinema attendances must fall.
But the cinema industry has been written off prematurely before: free-to-air TV, videos, DVDs, pay TV and now streaming services were each meant to kill the movies. Yet global box office revenue will rise from US$38 billion in 2016 to nearly US$50 billion on some projections.
In Australia, gross box office revenue of $1.245 billion in 2018 was almost a record ($1.259 billion in 2016), according to Screen Australia. The nation collectively went to the movies almost 90 million times to see 758 films released last year.
There’s no doubt that cheap content streaming services are a disruptive threat to the movie business and particularly free-to-air TV providers. The poor performance of US cinema stocks reinforces the market’s concerns about streaming and should not be discounted.
But cynics who compare the cinema business only to other content distribution channels are viewing the streaming threat too narrowly and may have overstated it.
Unlike Netflix, a cinema is part of the “experience economy”. People go to the movies for the big screen/sound/comfort experience and to enjoy the content in a group setting. You don’t get that watching a superhero movie on an iPad or smartphone.
Cinema is well positioned against competing experience-economy products. Try taking a family of four to a big football match (with good seats) for under $80. Cinemas are easier to get to, cleaner, safer and the quality of the experience is more predictable compared to sporting events that can be diminished by the weather or a boring game.
The other problem with comparing cinemas directly against streaming services is that the distribution channels complement as well as compete with each other.
My suggestion that we wait until Captain Marvel is on Stan, rather than pay $80 to see it, was ridiculed: “You have to experience a superhero movie for the first time on the big screen,” the kids protested. “Then you watch it again at home on a TV and later on the iPad.”
This anecdote shows how young audiences are prepared to watch prime movie content multiple times via different channels. They (or their parents!) might pay $20 for the cinema experience first time around, then a few dollars for the second viewing, then barely anything a year or two later on a streaming service.
The Queen biopic, Bohemian Rhapsody, could gross over $1 billion worldwide, partly because consumers in key Asian markets keep watching it. The movie’s great music and lead performance have made Bohemian Rhapsody the highest-grossing music biopic of all time.
The middle-class consumption boom in Asia and other developing markets is another tailwind for the global film industry. The most-recent James Bond movie, Spectre, broke records on its opening weekend in China in 2015. As Asian markets become familiar with Star Wars and other Western film franchises, ticket sales will soar.
Technology is another growth driver and a reason why the movie industry can stave off competition from streaming services and lift prices. The cinema that played Captain Marvel had noticeably larger seats that reclined and more leg room. Sensational screen and sound quality helped justify the ticket prices.
Many people complain about movie ticket prices but they have increased only 16% on average in 10 years – less than inflation – Screen Australia data shows. The average ticket price (remember, most tickets are discounted) was $13.68 in 2018. I suspect the industry has more scope to lift prices and boost margins than is obvious.
US cinema companies are innovating their pricing models by introducing subscription-like fees that allow a maximum number of monthly viewings. The Australian cinema industry can do more to innovate pricing and market directly to consumers through online channels and software algorithms that track their preferences and predict suitable content.
This commentary is not meant to underestimate threats for cinemas. Perhaps the biggest is smartphones reducing the attention span of young people and making it harder to sit through a two-hour movie, or TV streaming services taking hours of entertainment time (as people binge-watch popular series).
But I still like the cinema industry’s long-term prospects. And some blockbuster movies this year and next that are almost certain successes (notably Avengers: Endgame and another Star Wars instalment) could see the Australia industry break box-office records.
Here are the best ways to play the trend:
1. Content producers
Australian investors who want to invest in film studios must look overseas. None are better than entertainment behemoth, The Walt Disney Corporation (DIS: NYSE), owner of the Marvel, Star Wars and Disney character franchises, theme parks and other entertainment businesses.
Shares in Walt Disney fell to US$105 during the US share market sell-off in the fourth quarter and have since recovered to US$114. That equates to a forward price-earnings (PE) multiple of 15.6 times FY20 earnings, using consensus analyst estimates.
That is not excessive for a global business that owns some of the world’s great entertainment franchises and is superbly leveraged to benefit from growth in Asian movie consumption. Remarkably, Walt Disney’s PE is in line with the ASX 200 average in Australia.
An average share price target of US$126.45, based on the consensus of 20 broking firms, suggests Disney is modestly undervalued. If Avengers: Endgame, due in late April in the US, breaks the all-time box office record (US$2.78 billion for Avatar), Disney shares could reach the average broker target in a hurry.
The big question is how Disney maintains the momentum as the lucrative Avengers franchise winds down for a while and as superhero-movie fatigue grows.
Chart 1: Walt Disney Corporation
Source: Yahoo Finance
2. US cinema stocks
Australian investors must again look to the US for pure cinema exposure. Locally, Village Roadshow and Event Hospitality and Entertainment bundle their cinema chains with theme parks, property investment and other entertainment operations.
AMC Entertainment Holdings Inc (AMC: NYSE) is my preference. The US-based company owns the world’s largest cinema chain with more than 11,000 screens worldwide.
AMC and other US cinema stocks have disappointed over the past two years, amid concerns about competition from streaming services and the cinema industry’s long-term viability. But AMC’s fourth-quarter report, released in March, beat market expectation and its stock jumped 14 per cent.
AMC’s top-tier loyalty program – Stub A-List – is an interesting initiative. It allows members to watch three movies a week at AMC cinemas, in any format, for US$19.95 a month. The program already has 700,000 subscribers and AMC says it signed up 100,000 subscribers in just two months.
An average share price target of US$19.67, based on the consensus of 12 US broking firms, suggests AMC is undervalued at the current US$14.42. That might be too optimistic, but AMC has more momentum that investors expected and some big movies coming to its cinemas.
Chart 2: AMC Entertainment Holdings Inc
Source: Yahoo Finance
3. Australian stocks
I nominated Event Hospitality and Entertainment (formerly Amalgamated Holdings) as the pick of ASX-listed entertainment stocks for portfolio investors, for this report in May 2018 at 13.87. The stock hit $15.20 in mid-2018 and is now $12.90.
Event (ASX Code: EVT) earns half its revenue from cinemas, a third from its hotel chain (largely through Rydges) and the rest from Thredbo Alpine Resort and other property investments.
The cinema business performed better than expected in the first half of FY19 with Australian earnings up 10%. The Thredbo resort continued to improve, but the broader hotel business struggled. Earnings from Event’s German cinemas fell.
I still like Event, but it’s hard to see a near-term catalyst to re-rate the stock given the challenges in its hotel business as new supply enters the market and the economy slows. The good news is Event’s cinema business is returning to growth and performing better than expected.
Morningstar’s fair value of $13 for Event looks reasonable but implies there is not a sufficient margin of safety to buy the stock for now.
Village Roadshow (VRL) looks better value. Roughly a quarter of its revenue comes from cinema exhibition, a third from film distribution and a third from theme parks.
The stock has had a horrible five years (the annualised total return is minus 11 per cent) amid fears about Village’s debt, governance, the outlook for cinemas and the tragedy at rival facility Dreamworld (which affected attendance at all Gold Coast theme parks).
After hitting a 52-week low of $1.73, Village has rallied to $3.25 as the market prices in a stronger earnings recovery. Cinema division earnings leapt 22% to $16 million in the first half of FY19 thanks to stronger box-office conditions and better sales promotions.
Theme park attendance is recovering and Village’s properties are benefiting from new attractions, clever pricing and loyalty strategies, and perceptions that rival theme parks, notably Dreamworld, are tired and needing renovation.
Some brokers believe Village’s rally has taken it to fair value. A share-price pullback or consolidation in the near term is likely, but the rally can continue as blockbuster movies this year drive cinema earnings higher and theme park attendances improve.
Also, a highlight from Village’s latest result was its improved ticketing and promotional strategies that are lifting attendances and profit margins.
Macquarie Wealth Management’s $3.80 12-month price target suggests Village is undervalued at $3.25. It’s not a screaming buy, but institutional investors who have avoided the stock for years might start buying again as Village’s earnings recovery gains traction.
A sometimes volatile small-cap stock, Village suits experienced investors who understand the features, benefits and risks of investing in this part of the market.
Chart 3: Village Roadshow
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 13 March 2019.