Retail traders are once again pouring into heavily shorted stocks to trigger short squeezes, and AMC Entertainment (AMC -3.28%) is one of their main targets. Shares in this embattled movie theater operator have risen by a jaw-dropping 333% so far in 2021.
But is this price rally based on fundamentals or unsustainable hype? Let's dig deeper to find out.
What is behind the recent rally?
Trading at $9.18 at the time of writing, shares in AMC Entertainment are up in value by more than 50% in just over a week. The move coincides with a rally in GameStop stock, which has also enjoyed a surge in buying.
According to research from cybersecurity firm PiiQ Media, these moves may have been triggered by social media bots. But AMC also enjoys some fundamental tailwinds that could help justify the increased stock price.
The U.S. government is vaccinating over 2 million Americans per day against COVID-19. According to CNN, the country could reach herd immunity by June because of vaccinations and the natural defenses that previously infected people have developed. This trend is great news for AMC Entertainment, which relies on people visiting its theaters to generate revenue.
Third-quarter revenue fell 91% to $120 million because of a collapse in ticket purchases and food sales. But that's rock bottom, and things will likely improve from here.
Major markets like New York City are also relaxing restrictions (AMC will be partially reopening all 13 of its Big Apple locations starting March 5). And according to the National Association of Theater Owners, this move "gives confidence to film distributors in setting and holding their theatrical release dates, and is an important step in the recovery of the entire industry."
AMC still faces challenges
But the expected recovery in the theater industry doesn't necessarily make AMC shares a good buy -- and neither does its valuation. With a price-to-sales multiple of just 0.3, the stock looks cheap compared to the S&P 500's average of 2.8, but that valuation metric only tells part of the story.
The coronavirus pandemic has left the company's balance sheet in shambles.
Most recently, AMC raised $917 million in new debt and equity, which will increase the number of shares outstanding by 165 million (for $506 million in cash) and add a whopping $411 million to its debt load, which stood at $5.8 billion as of the third quarter. The potential for rising interest expense and debt amortization will pressure AMC's cash flow over the long term and raise the likelihood of future capital raises that could dilute current investors.
AMC is not a buy
AMC Entertainment stands to benefit from the winding down of the coronavirus pandemic and easing restrictions on its theaters. But the future is still far from certain. We don't know how long it will take for the industry to recover (if it ever does). And AMC may not generate enough cash flow to manage its debt without relying on equity dilution to plug the gap. Investors should avoid the stock until the company addresses these challenges.