Movie tickets cost too much. The popcorn is stale. Big-screen televisions offer a near-cinematic experience in the comfort of your own living room. Why should anyone go to the movies anymore?
It's an excellent question – but people clearly do. Despite all the obvious problems that confront cinema owners, the summer of 2013 produced record box-office revenue in the United States and probably in Canada as well.
From ticket sales to concessions, the companies that own the screens have been doing an admirable job of extracting more and more dollars from the dwindling number of folks who do show up. Their success has resulted in more revenue and more profits – and valuations for many theatre stocks make even tickets to their 3D screenings look cheap.
By bidding up the shares, investors are betting that the theatre chains can continue innovating in a century-old business and remain solid generators of cash.
But if we've already seen the best of the revenue-generating enhancements, the chains will, more so than ever, rise or fall on the strength of the studio film slate. At their current price levels, theatre shares carry significant risk if next year's roster of films proves disappointing, which suggests that investors in search of a Hollywood ending should wait for a more opportune moment to venture into the sector.
The biggest challenge before theatre owners? Movie-going is no longer the universal experience it once was. Ticket sales, on a per capita basis, have been declining for decades, notes analyst Liang Feng of Morningstar.
The Motion Picture Association of America estimates that 1.36 billion tickets were sold in the U.S. and Canada in 2012. While a jump over prior-year levels, that is below the 1.39 billion tickets sold 12 years before, in 2000.
To be sure, it's revenue that matters most, and the gross box office of $10.8-billion (U.S.) in 2012 was more than 40 per cent higher than 2000's $7.5-billion, thanks largely to higher ticket prices.
But last year's robust line-up of movies deserves some of the credit, particularly the James Bond saga, Skyfall, and the final instalment in the Twilight trilogy. That led to a particularly strong fourth quarter for theatres – one that will be hard to exceed, analysts believe, based on the slate of releases we'll see in the next three months.
Indeed, it sets up the prospects for disappointing fourth-quarter numbers in early 2014. "That's the problem for the exhibitors – they're completely reliant on the studios for movies that people want to go see," says Karen Berckmann, who covers the theatre chains' debt issues for Moody's Investors Service.
For now, however, the theatre chains are impressing Wall Street with their ability to extract more revenue from the folks who do attend. "It's about offering a more premium experience to the moviegoer, whether that's through large-format offerings like IMAX, their own large screens, or expanded concession offerings," says Townsend Buckles, an analyst with JPMorgan.
A good example of the premium strategy comes from AMC Entertainment Inc., which has just filed for an initial public offering of stock. It has been "reseating" its theatres with recliners or bigger, more comfortable chairs. "Even with fewer seats you can generate more attendance, because people like the experience of sitting in a big theatre," says Ms. Berckmann.
All the chains are rolling out more concession items, from simple offerings like pizza to full restaurants and bars at some locations. "I was quite skeptical of some of these food efforts, but they seem to be working out pretty well," Ms. Berckmann says. "It costs more to do some of these fancier things, but they're getting more dollars, and it's improving cash flow."
Canada's Cineplex Inc. is regarded as a pioneer in many of these areas. Its VIP areas offer bigger seats, food and wine, while its "UltraAVX" theatres feature reserved seating, wall-to-wall screens, "immersive" sound and large rocking seats. In the second quarter, Cineplex's "premium priced product" category (which spans 3D, IMAX, VIP and UltraAVX offerings) produced 42.2 per cent of its total box office receipts.
The question is how much further these premium services can expand before they hit customer resistance. Cineplex already leads North American movie chains in revenue per attendee, and it's outpacing the two large U.S. chains, Regal Entertainment Group and Cinemark Holdings Inc., in revenue and profit growth.
It also leads those chains in valuation, with a forward price-to-earnings ratio of more than 20, compared with Regal and Cinemark's P/Es of around 16.
When Haran Posner of RBC Dominion Securities Inc. assumed coverage of Cineplex with an "outperform" rating nearly a year ago, he titled his report "quality comes at a price" and called the stock "the new core holding in media" thanks in part to its "industry-leading execution" and attractive cash flow.
The shares have risen by more than a third since then, forcing Mr. Posner to reduce his rating to "sector perform" on valuation reasons. (His new target price of $39 is right about where the shares trade today.) He notes Cineplex is trading at the high end of its long-term valuation range, and its premium to its U.S. peers has rarely been greater.
Mr. Buckles of JPMorgan is generally positive about the industry, but runups in Regal and Cinemark shares this year have caused him to rate the stocks "neutral," with target prices about 10 per cent above current levels. Cinemark, he notes, has an attractive long-term growth profile because 30 per cent of its revenue comes from Latin America, where movie attendance is actually growing.
The one North American movie chain that is growing, however, is Mississauga's IMAX Corp. Morningstar's Mr. Feng, who is "not very optimistic about the long-term outlook for most regular theatres," says IMAX "occupies a much more favourable niche" with its large screens and special viewing technology. "The movies that are performing the best are the ones that are most differentiated from what you can get in front of your television," he says.
One of the main components of the IMAX story is the company's international expansion, which includes China and other emerging markets that are growing in attendance, unlike the U.S. and Canada.
"They're really in the best spot to benefit from the global theatrical trends," says Mr. Buckles of JPMorgan.
And investors will pay for this story: IMAX's P/E tops 30. Despite his optimism, Mr. Feng assigns a fair value to the shares of $24, versus recent trades around $29. "I would wait until it trades [down] a bit before I could comfortably recommend it. Mr. Buckles has an "outperform," but the shares are pushing his target price of $32.
That big bag of popcorn doesn't sound so expensive now, does it?