2023-06-15 11:11:17 ET
Summary
- The worst for the cinema business is over for now, however, I could see less demand for big screens in the next decades.
- The company is doing a good job at diversifying its offerings.
- Financials show a company that is still recovering.
- Slightly expensive for a new investor right now, with more uncertainty coming in the global economy.
Investment Thesis
With the world returning to normal after a tough period in the last few years, I believe that IMAX Corporation ( IMAX ) won’t go anywhere anytime soon, especially with how the company managed to diversify away from Hollywood and into local languages of cinemas all around the world. However, based on quite optimistic assumptions, the company is a little expensive right now and with a recession looming, I believe that a new investor will be able to get in on a lower price in the near future.
Outlook
The pandemic has accelerated the end of cinema all around the world with so many different streaming alternatives that you’ll never need to leave your house again. I thought the cinema would have been gone by now, however, it seems like people still like to go out to enjoy a new release with fresh popcorn/nachos and a big plastic cup of cola. There is something about looking at a massive screen and watching the new Avatar the way it was intended to be watched. The cinema business is not going away anytime soon but I do see it slowing down quite a bit over the next decade. The newest releases tend to come rather quickly onto the many streaming platforms these days which makes it even more convenient for people who may not have the time to drive and queue up for it.
IMAX has done a fantastic job during the pandemic when it reassessed its position in the business and went hard on local language cinemas all around the world to become the leader in this field. With the writers’ strikes in Hollywood and who knows what else might happen in the biggest film industry in the world, it was a very smart move to ramp up the diversification of cinema into local language films. In the latest quarter, the international market made up about a third of the company’s revenue already. The company isn’t going to slow this down because even though it’s not going anywhere soon, the popular cinema is going to come down significantly in the next decade in my opinion, and offerings in the local languages will have to pick up the slack. Adapting and evolving will be the top priority for the next decade for companies like IMAX to survive in this business and it seems like the company will do just fine.
Financials
At the end of Q1 ’23, the company had almost $100m in cash and $227m in long-term debt. Usually, I don’t mind the leverage on most companies. For IMAX, however, I think it’s a bit too much considering it barely made any operating profit last year. As of Q1 23, which was a much better quarter than the previous one, the company made $11.4m in operating profit while interest on debt was $1.7m. It looks like the company can handle the interest on debt, however, as of FY22 the interest coverage ratio was barely 2, which in my opinion is very low. It means that EBIT could only cover the interest twice over. The company’s cash balance would need to be used to pay it off, which means that the company would have less flexibility to do something more productive with it.
Continuing with liquidity, the company’s working capital ratio, or the current ratio, is pretty healthy and has been mostly healthy with a slight dip in ’20, which was not a surprise. The company, as long as nothing bad happens, will be able to cover its short-term obligations.
Current Ratio (Own Calculations)
In terms of efficiency and profitability, the company’s ROA and ROE have been quite bad even before the pandemic. These have recovered slightly, however, still well under my minimum threshold of 5% for ROA and 10% for ROE. I would need to have a couple of more annual reports to see if it’s beginning to trend upward. Even before the pandemic, the management was not able to utilize the company’s assets and shareholders’ capital very efficiently it seems like. That’s not a good sign.
ROA and ROE (Own Calculations)
The same can be seen in a company’s return on invested capital or ROIC. It was decent enough before the pandemic, however, it has not recovered to that number just yet, which to me doesn't seem like a good investment for now. These numbers tell me that the company had a decent competitive advantage and a moat but ever since the pandemic hit it has lost them and has not reclaimed them just yet.
The company’s margins have been worse, however, as of FY22 these have not improved sufficiently yet. I’d like to see at least the numbers of ’19 but that may take time.
Overall, these numbers do tell a company that is still recovering from the pandemic panic and still has a long way to go. I would be cautious for the next couple of quarters, considering that there is going to be a recession (supposedly) coming very soon.
Valuation
I decided to be quite optimistic about this valuation model to see what can be achievable for IMAX if everything goes well. For the base case revenue assumptions, I went with 25% growth in '23, dropped it down to 15% for '24, and linearly grew it down to 5% by '32, giving me around 12% CAGR for the decade which I think is quite optimistic, but I’ll stick with it. I usually tend to be more conservative. For the optimistic case, revenue will grow at 15% CAGR for the next decade, while for the conservative case, it will grow at 9.5% CAGR.
On the margins side, for the base case, I decided to be very generous with the operating margins. I decided to improve these by around 10% linearly over the next decade while gross margins will improve by 2% over the same period. This means that net margins will go from -8% in ’22 to around 11% by ’32, which is just slightly below ‘19’s margins. I think that's quite reasonable to assume that the company, if it is not bankrupt by then, will achieve better efficiency in the next decade.
For the optimistic case, margins are slightly better, and for the conservative case slightly worse compared to the base case scenario.
I will also add a 35% margin of safety on top of these calculations because the financials were not very good in my opinion and the assumptions were on the optimistic side also. With that said, the intrinsic value of IMAX is $14.63, implying around 20% downside from the current valuation.
Intrinsic Value (Own Calculations)
Closing Comments
I don’t think that it’s worth selling your shares even if my valuation says it's overvalued right now. The worst for now is gone for IMAX in my opinion. If I was already invested and have been invested through the worst of '20, I wouldn't be selling it right now as the potential for a comeback is close, with the diversification efforts showing good results and people still wanting to go to the cinemas for that experience of tasting the popcorn cinema which is always better than the microwaveable ones and sit in the dark cinema with no distractions, hopefully.
There are many films still coming to the big screens this year and with China’s re-opening of the economy, the demand will keep ramping up and I wouldn’t be surprised to see similar numbers to pre-pandemic eventually, if only for a brief moment.
I will hold off from starting a position at these levels because I would like to see a couple of more quarters of results and how the economy develops further in terms of inflation, interest rates, etc.
For further details see:
IMAX Corporation: Coming Back To Life