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Tuesday, July 1, 1997
Movie Gallery,
Inc. HOW DID IT FIND TROUBLE? After trading up to $50 a share in the third quarter of 1995, Movie Gallery has displayed all the crash-'n'-burn thrills of your basic disaster flick. For a year now, investors have been diving overboard as the shares just kept sinking, hitting a titanic low of $4 7/8 in April. Despite fears that video-on-demand would kill the video rental biz, the real culprits have been overexpansion; a more fickle consumer that's forced operators to buy more copies of the top new releases; an increase in the lower-margin sell-through market; and possibly even the rise of the Internet as a leisure activity. Movie Gallery's disastrous financial results have been framed by slumping sales and write-offs to close underperforming stores. Plus, as inventories lose value more quickly now, accounting changes were implemented to speed up the amortization of videocassette costs, a move that walloped earnings per share (EPS). Despite news of two new acquisitions, the shares dropped from $32 to $15 last summer after the company announced the accounting change. The stock was again reeling come September following news that the chain would take a $9.6 million pre-tax restructuring charge to close 50 stores and reduce staff by 15%. The rewind has continued this year, with analyst downgrades hitting the stock in late April prior to the report that same-store sales, off 1% in the fourth quarter, fell 5.7% in the first quarter. On the positive end, Movie Gallery managed to meet the reduced estimates of $0.15 a share and its own version of EBITDA showed an improving cash position. BUSINESS DESCRIPTION Based in Dothan, Alabama, Movie Gallery owns and operates 861 video specialty store, with 106 franchisees, making it the second largest U.S. video retailer in number of locations, and third largest in revenues, behind VIACOM'S (AMEX: VIA) Blockbuster and HOLLYWOOD ENTERTAINMENT (Nasdaq: HLYW). Stores are concentrated in small towns and suburban areas near small cities, mainly in the Southeast, though the company has expanded into New England and the Midwest through recent acquisitions. The company has acquired 697 stores in the past three years to become a major player in a business with estimated total annual revenue (sales and rentals) of $16 billion. About 70% of the nation's 27,000 video stores still operate independently or as part of small chains. FINANCIAL FACTS Income Statement* 12-month sales: $257.6 million
12-month income: $9.7 million
12-month EPS: $0.72
Profit Margin: 3.8%
Market Cap: $93.8 million
(*Excludes $18.1 million in one-time charges for Q2 and Q3 FY96)
Balance Sheet
Cash: $5 million
Current Assets: $21 million
Current Liabilities: $30.6 million
Long-term Debt: $69.8 million
Ratios
Price-to-earnings: 9.7
Price-to-sales: 0.36
HOW COULD YOU HAVE SEEN IT COMING? Despite the firm's good track record and positive press through the middle of 1995, there was one good reason to believe that the exceptional growth being projected for the top video retailers was overstated: Wayne Huizenga had been willing to trade in his stake in Blockbuster Entertainment for shares of Viacom. Doubts expressed in Forbes over accounting methods at Hollywood Entertainment might have highlighted changes in the entire industry, as customers grew less enticed by the back-catalog and more interested in renting the hits when they came out. More recently, the drop in same-store sales added new reasons to see more trouble ahead for Movie Gallery. WHERE TO FROM HERE? Despite recent downgrades, First Call consensus EPS estimates call for $0.93 for FY97 and $1.14 for FY98, or $0.70 and $0.82, respectively, if you go with the low estimates, as might be prudent. Using a long-term growth rate of 20% gives us a YPEG of at least $14, suggesting that Movie Gallery could be a hit with investors at these prices. Still, questions abound. The company's growth depends on acquisitions, which should pick up again in the second half of the year -- if the company can arrange financing. Acquisitions are crucial because, while there's room for further consolidation in the video rental market, sales overall grew by just 1% in 1996. Though the firm's working capital is officially negative, that's more an artifact of the accounting requirements than of the company's financial health, which has shown some improvements following the staff reductions. Still, Movie Gallery did lose its chief operating officer in March. Then there's the latest fear: that the advent of DVD technology will eventually eat into the rental business while forcing stores to add movies in a whole new format. Of course, a summer of successful blockbusters could pay off nicely for Movie Gallery this fall. -Louis Corrigan (RgeSeymour@aol.com)
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