Cineworld (LSE: CINE) is one of many stocks currently trading at mind-boggling discounts to their previous highs. Over 80% in Cineworld’s case! Could it be one of the biggest bargains of the stock market crash? If you’re tempted by the Cineworld share price, here’s what I think you need to know.
Cineworld’s share price is standout cheap
As a result of shuttered cinemas during the coronavirus lockdown, 2020 is going to be a washout for Cineworld. Indeed, City analysts expect the company to make a hefty loss. Meanwhile, the board announced a suspension of dividends for the year as long ago as April.
However, looking ahead to 2021, analysts have pencilled in an earnings-per-share (EPS) recovery to around 17 cents (13p at current exchange rates) and a dividend of around 8 cents (6.1p). The Cineworld share price is currently around 53p. Therefore, the forward price-to-earnings (P/E) ratio is just 4.1, and the prospective dividend yield is 11.5%.
If you think that’s standout cheap, the valuation looks even more extraordinary calculated on Cineworld’s pre-pandemic peak EPS and dividend. On this basis, the P/E is 2.7 and the dividend yield is 22.3%. Wow!
Is the Cineworld share price too good to be true?
They say if something looks too good to be true, it probably is. With this in mind, even though the Cineworld share price is at a huge discount to its previous high, investors need to consider whether there are still substantial downside risks.
Several things give me cause for concern. First, it’s worth noting that the Cineworld share price had fallen around 40% from its high — even before the pandemic-inspired stock market crash.
Writing on the company last September, I expressed my scepticism about the advisability of its move into the US market via the previous year’s $3.6bn reverse takeover of Regal Entertainment. My concerns included the structural decline in North America cinema attendance, and Regal’s underperformance versus peers.
Subsequently, I was unimpressed by Cineworld’s proposed debt-funded $2.1bn acquisition of Canada’s largest operator, Cineplex. Cineworld’s debt was already at an elevated level of 3.3 times EBITDA.
My concerns were further compounded by a report from research house Bucephalus. It suggested Cineworld’s accounting was extremely creative and that, on a true view, its debt was more like 9 times EBITDA.
Finally, through the second half of last year, hedge funds were increasingly betting against the Cineworld share price. Short positions rose to such an extent that it became London’s most heavily shorted stock.
Debt can be deadly
The pandemic has dealt Cineworld a severe, and potentially, even lethal blow. Despite backing out of the Cineplex acquisition (the two companies are now locked in a legal battle over damages), Cineworld’s debt is looking more onerous than ever.
It’s been seeking additional borrowing wherever it can find it. US and UK government emergency loans, a $110m increase in its revolving credit facility, and a new $250m secured debt facility. I dread to think what the annual cost of servicing its debt is now. It was running at $568m last year.
It really looks to me like Cineworld will sooner or later have to do a debt restructuring. If so, I think it’s highly likely existing shareholders will be significantly diluted in a debt-for-equity swap. As such, I’m happy to continue avoiding the stock for the time being.