Stars Aligned for This Recession Fighter

04/08/2009 12:00 am EST

Focus: GLOBAL

Gavin Graham

Chief Strategy Officer, INTEGRIS Pension Management Ltd

Gavin Graham, contributing editor at The Canada Report, likes Cineplex Galaxy's movie theaters as a hard-times hedge.

Cineplex Entertainment, the operating company for Cineplex Galaxy Income Fund (TSX: CGX.UN, OTC: CPXGF), is the largest film exhibitor in Canada, with 131 theaters and 1,321 screens in six provinces. This represents about 70% of Canadian box office revenues.

Historically, cinema attendance has been resilient during economic downturns. This is because it is a relatively low-cost outing which is one of the last activities to be cut, and benefits from consumers who "trade down" from more expensive outings such as dinner or theater. [And] 2009 has what looks like a strong slate of forthcoming films that include the delayed sixth installment of the Harry Potter series, a new Star Trek movie, and a Transformers sequel.

The recently released fourth-quarter results for Cineplex showed unexpectedly strong attendance, record concession revenues, and only slight weakness in advertising during a quarter when the Canadian economy fell into a recession.

Cineplex also has a clean balance sheet, a factor of great importance in these credit-constrained times. Since making the Famous Players acquisition in 2005, which saw the ratio of debt to EBITDA (earnings before interest, taxes, depreciation and amortization) rise from two times to six times, it has used most of its excess cash flow after distributions to reduce this and other debt. As a result, the debt-to-EBITDA ratio has declined to 2.5x. Cineplex does not need to refinance its existing debt until 2012.

Furthermore, RBC Securities has calculated that Cineplex is generating sufficient cash flow to enable it to increase its payout by 3% per year until 2011 and then it would not need to cut its distribution even with the introduction of the income trust tax at the beginning of that year. While Cineplex did not announce an increase in distributions along with its strong fourth-quarter results, the implied stability of its payouts between now and 2011, let alone after the introduction of taxation on trusts, makes it especially attractive.

[Also,] Cineplex has not relied on ticket price increases to drive the bottom line. Instead, it has concentrated on attracting more patrons to its cinemas, including scheduling live events in "high definition" such as hockey games and opera performances, and with its innovative "Scene" loyalty card program.

The units are currently paying a monthly distribution of 10.5 cents Canadian ($1.26 annually), yielding 8.9% for holders of shares traded in Toronto. As with all income trust distributions, US investors will be subject to a 15% withholding tax, which may be reclaimed as a foreign tax credit. If possible, purchase the shares on the [more liquid] TSX.

(Editor's Note: On March 30, Onex Corp., the private equity group and a key long-term investor, said it would sell a 23.5% stake in the company via a secondary offering. The stock, which had run up 7% during the month, gave it all back in Toronto, but hasn't traded since on the Pink Sheets in New York.)

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