SIX - Six Flags Entertainment: Get Ready For Things To Get Worse Before It Gets Better

2023-09-20 05:46:10 ET

Summary

• Six Flags reported lower-than-expected revenue and a decline in spending per visitor.
• The company's value pricing strategy is gaining traction, but it may result in unfavorable year-over-year comparisons.
• Increased capital expenditures to enhance park aesthetics and guest experiences are a positive long-term move, but they will temporarily impact cash flow.

Summary

Readers may find my previous coverage via this link . My previous rating was a hold for Six Flags Entertainment ( SIX ) stock, as I thought it was better to wait a couple of quarters to evaluate how successful the turnaround efforts were. I am reiterating my hold rating as I believe SIX is going to see weaker results in the near term before turning for the better. The turnaround outlook certainly has potential, but I would rather these efforts crystallize in the financials before investing.

Financials / Valuation

SIX reported 2Q23 revenues of $443.6 million, which was lower than the $465.3 million predicted by consensus. Higher attendance and lower ticket prices and spending per visitor drove results, while higher sponsorship revenue helped to offset some of the negative effects. Quarterly attendance was up 6% year over year to 7.1 million, but would have been even higher if not for the effect of severe weather on parks in California and Texas. Spending per capita by visitors fell 5% to $60.76. On the expense side, SG&A (excluding stock compensation) increased by 75%, largely due to increased advertising expenditures. As a result, the company reported adj. EBITDA of $160.8 million vs. the consensus estimate of $168 million.

My view on SIX potential upside has not changed if it is successful in this turnaround. it should be able to grow EPS 15% (mid-teen range), as per its historical pre-covid range (range between low-teens to 19%). Hence, in my DCF model, I forecast EPS to grow at 15% for the next 5 years before leveling off to an annual growth rate of 2% thereafter. I have placed a higher discount rate of 12% given the elevated execution risk and cyclicality of the business. Note that I used $1.60 for the base EPS as I annualized 2Q23 EPS performance (LTM is not representative as they saw losses in 1Q23). With these assumptions, I got a similar target price of ~$27. This represents a 19% upside, and while attractive, I think the upsides are likely to be back-end loaded when SIX shows actual results via its reported earnings. As for now, the market is unlikely to rerate the stock.

Comments

Overall, I maintain my hold rating as I think there is still a lot to be done before the market will give SIX credit for their turnaround efforts. There are two things I am monitoring here: spending per capita trends and SIX investments (CapEx).

First, I anticipate that the dismal trends in spend per capita will worsen before they improve. It came as quite a surprise to me, as I had anticipated a better performance from this metric than a significant drop of 5% to $60.76. According to management, this was the result of higher season pass attendance and a combination of factors, including tough pricing comps that had recently ended and reduced spending on parking, retail, and flash passes. The former part of the explanation is the most interesting to me because it suggests that SIX's value pricing strategy is working. I anticipate this trend to continue gaining traction, which means that in the near future, SIX financials will likely be a combination of a rise in the sale of value-priced tickets (season pass) and challenging year-over-year comparisons, which is not pretty from a headline perspective. Indeed, management conveyed this via their 3Q guide , predicting a -7% trend in admissions and a 100-200bps sequential decline in the trend of total per caps. Since most price increases occurred in July and August of 2022, I anticipate that this year's trend in admissions per capita will be hampered by unfavorable comps during those month.

Secondly, I am net positive on the management decision to invest in attractions. The reason I said "net positive" is because the near-term cash flow is going to see a dip from these investments. Management significantly increased capex guidance for 2023–2025 on the call. The previously anticipated $150 to $200 million in capex has been significantly increased to a range of $200 to $220 million and $230 to $250 million for 2024 and 2025, respectively. I view this as an essential move in order to stay relevant. Rather than focusing on adding new attractions, park management has recently prioritized enhancing the park's aesthetics and the guest experience. As a result, I believe that investing in new attractions could be a catalyst to attract a new crowd back to the park. However, timing is an issue, especially if SIX is planning to invest in major attractions (which, by definition, will take longer to construct). As such, revenue from these new attractions is likely to flow in in FY25. This dynamic is unlikely to be in favor of investors as it increases the risk of investment (what if the park doesn't do well?).

So overall, SIX has a promising turnaround path ahead of it. However, in the near future, the business is expected to see weak spending per capita as: the mix of value-priced tickets goes up + tough comps in Q2 + elevated CAPEX. Which, put together, would mean investors are likely going to continue sitting this one out until they see actual results. I do give merit to management’s long-term strategy, and that valuation has certainly come down to an attractive level relative to history. However, I retain my recommendation to wait for the turnaround efforts to further crystallize before considering a buy.

Conclusion

My outlook for SIX remains a cautious hold. While the company is on a promising path towards a turnaround, the near-term outlook appears challenging. The decline in spending per capita, influenced by various factors including higher season pass attendance, suggests that SIX's value pricing strategy is gaining traction but may lead to unfavorable year-over-year comparisons. Additionally, increased capital expenditures to enhance park aesthetics and guest experiences are a positive long-term move, but they will temporarily impact cash flow.

Investors should be prepared for weaker results in the short term, driven by these factors. Although management's long-term strategy is commendable, and the valuation is becoming attractive, I advise waiting for more concrete results and a clearer picture of the turnaround efforts before considering a buy. Overall, it's important to exercise patience as we navigate this transitional phase in SIX's journey towards improvement.

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