Wednesday, August 19, 2009

Volume 3, Issue #79

Also in Today's Issue...

Regal Entertainment Group (NYSE: RGC) is the nation's largest movie exhibitor, with a coast-to-coast network of 550 theatres and over 6,800 screens.

There has been a great deal of consolidation in the movie business over the past decade, and Regal has been a hungry fish in a shallow pond. Today, the company operates in 44 of the country's top 50 markets and has an industry-leading 16% market share.

But management is always on the lookout for potential acquisition targets. And once new theatres join the family, they are usually quick to trim expenses and improve profitability -- if for no other reason, Regal's size means better film licensing deals and favorable contracts with concessions suppliers.

It's also worth noting that Regal's theatres are among the best in the industry. Nearly three-fourths offer plush stadium-style seating, and all are being outfitted with advanced Sony 4K digital projection systems that produce stunning resolution and picture quality (8.8 million pixels). This will help keep the company a step ahead of its outdated competitors.

This can be a tough business at times. Movie studios often have the upper hand at the bargaining table, and occasional dry spells at the box office are to be expected. But there are plenty of advantages as well.

For example, multiplex owners have a largely fixed cost structure, so business tends to be scalable. Expenses such as rent and labor generally remain the same whether a theatre is sparsely crowded with a handful of people or slammed with several hundred. That operating leverage means incremental income from extra visitors flows right to the bottom line.

We've seen this in action lately. Approximately 66.3 million people attended a Regal showing last quarter, nearly 7 million more than the same period last year. Those customers also shelled out $8.17 per ticket, up from $7.63 the year before.

That combination propelled revenues up +17% for the quarter, which easily outpaced the +13% increase in expenses. As a result, operating margins expanded by over 260 basis points and free cash flows surged +170% to $0.74 per share.

Going forward, my staff and I feel that attendance will continue trending higher as consumers realize that movies are relatively inexpensive next to concerts, sporting events and other entertainment venues.

Despite a sagging economy, Regal attracted nearly a quarter of a billion visitors last year. And those customers aren't sitting through Harry Potter and the Half-Blood Prince or Ice Age: Dawn of the Dinosaurs empty-handed -- sales of popcorn, beverages and other concessions are ticking higher as well.

But the climactic finish is still to come.

Regal has invested aggressively to transition from yesterday's 35-mm film to superior IMAX and digital 3-D formats. This electronic distribution provides greater programming flexibility and will enable Regal to more profitably utilize its floor space. More importantly, movie buffs are happy to pay premium rates for a more immersive experience.

All of this should keep cash popping out of the bin, and management likes to serve it right back to shareholders -- generous quarterly dividends of $0.18 per share add up to a satisfying yield of 6.2%.

Action to Take --> Regal is strengthening its balance sheet, upgrading its facilities, and investing in new ventures like in-theatre advertising. And the company just posted record-breaking sales and profits. Yet, the shares are still trading at an attractive Enterprise Value/EBITDA below 7.

-- Nathan Slaughter
Editor
StreetAuthority Market Advisor