According to a recent Bloomberg study, 30% of surveyed economists believe the U.S. economy will enter a recession in the next 12 months. And the prospect of the Federal Reserve increasing interest rates to fight inflation is another challenge for debt-heavy businesses like Six Flags Entertainment (SIX -1.99%).
Let's explore why the bear market may be just beginning for this iconic amusement park operator.
What is Six Flag's business model?
Six Flags is a regional theme park operator with a portfolio of 27 parks located across North America. Like most in-person entertainment businesses, the coronavirus pandemic was a massive challenge, keeping its parks shuttered for much of 2020 and 2021.
But now that the company is back to normal operations, the result still leaves much to be desired.
Image source: Getty Images.
Total revenue jumped 68% year over year to $138 million, with the net loss narrowing from $96 million to $66 million. While this is a massive improvement, Six Flags faces easy comps because many of its properties were shut down this time last year. Revenue is up by a more modest 8% compared with the first quarter of 2019 before the pandemic.
That said, the first quarter is Six Flags' slow season. With amusement park traffic tending to pick up during the warmer summer months, the company could quickly swing to profitability in the second and third quarters.
So why is the stock down 47% year to date? Simple: the balance sheet.
Rising rates and possible recession will be massive challenges
Six Flags has historically relied on debt financing to invest in capital projects like new rides at its properties, and the cash flow constraints during the pandemic made its leverage more severe. As of the first quarter, the company reports $2.63 billion in long-term debt compared to just $252 million in cash and equivalents. This disparity puts it in a vulnerable position in this macroeconomic environment.
With the U.S. inflation rate hitting 8.6% in May, the Federal Reserve is expected to continue raising interest rates and tightening its balance sheet -- moves that will dry up liquidity in the economy and increase the cost of capital. For Six Flags, this could mean higher costs if it seeks to refinance its debt, which could put pressure on cash flow.
But while interest rates pose an inconvenient but survivable challenge, an economic slowdown could worsen significantly. As an amusement park operator, Six Flags' business is considered consumer discretionary, meaning it is a non-essential expenditure typically cut in a bad economy. The company went bankrupt in 2009 (following the 2007 recession) after struggling to refinance $2.4 billion in debt. And with even more leverage this time around, another economic slowdown may be even tougher to deal with.
More downside is likely
Despite rapidly improving business performance, Six Flags' stock looks poised for more downside. The company's massive debt load and consumer discretionary business model make it vulnerable to macro-economic challenges like higher interest rates and possible recession. While investors probably shouldn't assume the company will go bankrupt again, these challenges could hurt the stock's performance.
