Why Has AMC Stock Jumped In July And What’s The Outlook?

Introduction

As the apes from the meme armies went to war against short-sellers, AMC Entertainment (NYSE:AMC) enjoyed its moment in the sun, with its stock rising from $10 to more than $50 early last year. The company was quick to capitalize, issuing gobs of stock, followed by its executives cashing out.

Now the apes are bored, and the stock is languishing at the $15 level, down 40% for the year. The last month has been good, however, with the stock rising 20%, including 12% in July. A dead-cat bounce or a sign of things to come? I offer a fundamental perspective for those who are so inclined.

Company background

AMC has a simple business. Build or rent theaters, screen movies, sell tickets and peddle overpriced refreshments. It operates mainly in the US and also in Europe and Saudi Arabia. International markets account for about 30% of revenue.

This is a tough business to be in. Moviegoers are gravitating towards watching mega-hits in whichever theater is screening it, thus dampening any brand loyalty towards a theater company. Hollywood squeezes as much as it can from theaters, as a result of which almost all the ticket price goes to the industry, including middle-aged actors reprising their heart-throb roles from decades ago. Theaters are left to try and cover their expenses by marking up their food and beverages by 6x.

Financial overview

For the first quarter of 2022, the company generated $785 million in revenue. Operating income was a loss of $167 million, and net income was a loss of $337 million or $0.65 per share after interest and some other expenses.

The company currently has 515 million shares (up from 400 million a year ago) and a market capitalization of $7.8 billion. It has $1.2 billion of cash equivalents and $5.6 billion of debt for net debt of $4.4 billion. Thus, I calculate an enterprise value of $12.2 billion.

The bull case here is predicated on Covid dissipating and people flocking back to movie theaters. The company had revenue of $5.5 billion in 2018 and 2019. Operating income was $310 million in 2018 and $236 million in 2019. So in the best case, I believe the company can get back to the $300 million range for operating income. After deducting $90 million for interest expense, you would be left with pre-tax income of $210 million. Since the company has racked up huge losses in the last few years, it will be able to use those past losses to shield profits from taxes for a long time. So I will assume taxes paid would be zero. So the net income would amount to $0.40 per share. For reference, the average analyst estimate is for the company to generate $5.2 billion of revenue and a loss of $0.46 per share next year.

Why has AMC stock gone up, and can it continue to do so?

Theater attendance has picked up in the last few months, with more people comfortable sitting in a crowded theater to watch the latest hit. However, I do not believe this has been the primary reason for the stock’s rise.

The stock has a high short interest of 20% of outstanding shares being shorted. In times of market turmoil and elevated volatility, many funds will tend to de-gross, i.e., they will sell their long positions and cover their short positions in order to reduce their exposure to the market. Many highly shorted stocks are up in July, including GameStop (GME). It appears that this phenomenon has benefited AMC this month. I do not believe this is sustainable as the Federal Reserve is poised to increase interest rates again at the end of this month, thus tightening the money supply. Short sellers have to pay to borrow the stock, but also get a rebate tied to the Fed funds rate (as short selling a stock generates proceeds that can be invested by the broker in safe short-term government securities). As this rate goes up, it becomes relatively more attractive to hold a short position. Thus, I do not see the stock’s outperformance continuing.

Valuation: Fair value of $8 per share

I believe the shares deserve no more than a 20x multiple on the optimistic estimate of the company being able to earn $0.40 per share, resulting in a fair value of $8 for the shares. Thus, there is substantial downside from the current $15 share price.

In a bull case, the company will be able to cut costs and increase revenue beyond expectations, generating $400 million of operating income. This would result in $310 million of net income or $0.60 per share. Enthusiastic investors paying a 30x multiple on this would result in a share price of $18 or 20% upside from the current level.

In a bear case, the company will be able to get to only $200 million of operating income, resulting in $110 million of net income or $0.21 per share. A 20x multiple would result in a $4 share price. I would also add that the company faces a non-trivial risk of bankruptcy if it is not able to generate enough operating income to cover its interest expense and is unable to roll over its debt.

Quant and external ratings

The company’s SA quant rating is 1.9, equating to a sell. Looking at its factor grades, it garners a D- for valuation, a B for growth, D for profitability, C for momentum and D+ for earnings revisions. Not a good picture, and it’s no surprise that Wall Street analysts are negative on the company as well. They have a composite rating of 1.9 on it, equating to a sell. I believe these are the right calls, but everyone being uniformly negative on the company gives me pause.

Risks are high

The risks here are high for both a long or short position. With the company’s high debt load and interest expense, any operational improvements or misses get magnified for equity holders. Anyone without a high tolerance for risk would be better off avoiding the stock.

The short interest here is high and there could be another short squeeze like there was last year. However, with money getting tighter, I would regard the chances of this happening to be low, but not zero.

The company could be acquired at a premium by another company or private equity. I do not see any obvious buyers, but anything is possible in M&A! This is a risk that can be diversified by holding a large number of short positions with each one being small.

Investors may decide to be optimistic about the company’s future profitability and pay a higher price for the stock.

Pre-emptive disclosure

Writing a short thesis on a stock on a public forum is an invitation for blowback from holders of the stock. I welcome respectful comments from eponymous readers.