Forget Hollywood: How to Invest in the Box Office Itself

Down in front! This consumer goods edition of Industry Focus takes you to the box office with a look at the movie theater industry. Tune in for details on the big four chains, growing trends, and two Fools' personal favorites.

Consolidation over the past 15 years has nearly doubled the four leading theater chains' share of box office revenues, while the changing face of entertainment in the age of YouTube and Netflix is shrinking attendance. But it is a mature industry that is fighting back with special amenities, international expansion, and location-targeted strategies.

A full transcript follows the video.

Sean O'Reilly: Get your popcorn ready! We're talking movie theaters on this consumer goods edition of Industry Focus.

[INTRO]

Greetings Fools, I am Sean O'Reilly here with the one and only Vincent Shen, and we are joining you from Fool Headquarters in beautiful Alexandria, Virginia. How are you doing today, Vince?

Vincent Shen: Doing well, as always. How are you, Sean?

O'Reilly: Not too bad. We're on the cusp of spring, and I'm waiting and waiting and waiting because I want to run on the waterfront, I want to get into the District.

Shen: Yes, of course. Of course.

O'Reilly: We're talking movie theaters here, and the big business that is Hollywood.

Shen: Yes. I'm very excited about today's show. I think it's an interesting business, that's for sure.

O'Reilly: What was the last movie you saw?

Shen: In theaters?

O'Reilly: Yes.

Shen: That's actually a good question.

O'Reilly: See?

Shen: It might have been Interstellar. Or Mockingjay.

O'Reilly: Really? Wow.

Shen: Yes, it's been a while. I haven't been to the theater in a long time.

O'Reilly: You need to get out more. My wife and I, we actually enjoyed it a lot, we went to see Into the Woods.

Shen: You liked Into the Woods?

O'Reilly: Yes, it was a good time.

Shen: Okay, I have to question that, because I was not a fan.

O'Reilly: I'm married, I have a child. We've got to get out and ...

Shen: I guess that's fair. I guess that's fair.

O'Reilly: They put fun spins on these age-old tales.

Shen: I will admit that I walked into that, not knowing that it was going to be sung.

O'Reilly: Oh, so you're making fun of me for something that you saw as well.

Shen: Yes, I saw it.

O'Reilly: Okay. See how I trapped you there?

Shen: I did not choose to see it willingly. All right, let's get on to the ...

O'Reilly: My wife dragged me too! Anyway.

First and foremost, we're going to talk about the size of the market we're talking about. We're not necessarily going to be talking about Paramount Studios or anything.

Shen: No, no, no.

O'Reilly: We're talking about movie theaters and concessions and how to invest in people actually going to see movies when they come out.

Shen: Exactly.

O'Reilly: How big is this market? What are we looking at here?

Shen: The United States is the biggest generator of box office receipts worldwide.

O'Reilly: The gap is narrowing, but for our purposes we're going to talk about the United States.

Shen: Exactly. It's still by far the number one country for ticket sales with about $10.3-10.4 billion in sales in '14, last year; about 1.27 billion actual ticket sales.

Whereas China, which I believe is number two, is the first international market to break $4 billion, to give you some perspective in terms of the general dominance for U.S. box office receipts.

O'Reilly: Right. These numbers, the represent a slight pullback from the previous year.

Shen: Exactly. Domestic box office receipts have seen a compound annual growth rate of just a little over 1% over the past decade, but from 2013 to 2014 it actually fell 5%, which is one of the biggest percentage drops over that same decade.

O'Reilly: Does that include the obvious increase in ticket prices that I've been paying, ha, ha, ha?

Shen: Yes, exactly. They've seen drops in not only overall box office receipts, but also their ticket sales. The number of tickets sold has fallen about 20% since 2002; so ticket prices will go up a little bit to help bolster their revenue, but as a result they're seeing weakening demand.

O'Reilly: As potential investors in this sector though, thankfully ticket sales are actually not how these movie theaters make their money.

Shen: Well, it's definitely a combination. For most operators, they'll break down their primary revenue streams into their admissions -- the ticket sales that you would expect -- and also of course their concessions, which is really their bread and butter, due to the insane margins in this industry.

O'Reilly: I love my $8 popcorn.

Shen: Exactly, $8 popcorn that probably cost them maybe $0.20.

O'Reilly: Not even.

There are four big companies that we're looking at here that cater to the American public that see movies right when they come out. You're talking AMC Entertainment (AMC -3.25%), Regal (NYSE: RGC), Cinemark (CNK -0.67%), and IMAX (IMAX 1.26%); they've got screens at science centers too, but IMAX as well. Then there are obviously local theaters; this, that, and the other thing.

Kind of a diverse bunch when it comes to financial results. I was surprised to look at this. You've got AMC, a trailing P/E ratio of 52.5, trailing return on equity of 4.2%, and year over year growth this past fiscal year that ended December 31 of -2%. This is across 348 theaters. This is a big ... it's AMC. This is not Google profits here.

Shen: It's interesting. When I think of movie theaters, I thought of the big four like you mentioned; Regal, AMC, Carmike (NASDAQ: CKEC). But something that really surprised me was that there are actually still 1,400 theater operators in the U.S. and Canada.

O'Reilly: Wow.

Shen: A very common theme that has been prevalent in the industry for really the past decade, or even more, is consolidation. In 2000, the biggest four theater operators accounted for about 35% of box office revenues, but due to that consolidation since 2000 they now make up about 61% in 2014.

O'Reilly: Of the market, yes.

Shen: They're getting bigger and bigger. The top four are basically taking a bigger and bigger piece of the pie for the industry.

O'Reilly: Which of these companies do you like the most?

Shen: I'm kind of torn because some of them have their advantages, and certain exposure to international markets, for example, that I think is a good avenue for growth.

O'Reilly: AMC has kind of gone the urban route with a lot of their theaters.

Shen: Exactly. They have 41% of the revenues and 38% of their attendance concentrated in their top five markets, which is New York, L.A., Chicago, D.C., and San Francisco.

They see that as being strategic because their attendees in these areas tend to be more affluent. They lead in terms of revenues per patron, average ticket price, concessions per person. That's been their strategic focus.

O'Reilly: I have to wonder though, because that was immediately what I thought when I looked at these return on equity numbers, though.

You compare them to a Cinemark, which is not as urban; they're a little more spread out. They've actually got even more theaters spread across the country. But very consistent returns on invested capital, everything. Last year their returns on equity were 17.4%. The average S&P 500 corporation is 12, so that's awesome.

Shen: Yes.

O'Reilly: I have to wonder if AMC's strategy is going to pay off, because you mentioned the top five markets, but real estate costs a little bit more in those, too!

Shen: Yes, of course. I think that being concentrated in urban areas -- from my experience, having regularly gone to theaters in places like New York and here in the D.C. region when you're paying $12-13 a person, it explains how they're able to command that higher average ticket price.

O'Reilly: Right. What's the deal with the dividend yield on some of these companies? I was actually surprised to learn that they pay out a decent ...

Shen: Yes, absolutely. Regal is yielding about 3.8%, AMC is yielding about 2.2%, whereas Cinemark is at 2.3%. Carmike is the only one that does not pay a dividend.

O'Reilly: Kind of surprising.

Shen: Regal even announced a special dividend in mid-December of $1 per share.

O'Reilly: Yes, they're not doing too bad. The revenue picture was pretty similar to AMC and Cinemark -- they all pretty much fell about 1.2-2% -- but return on equity is 7.5%, trailing normalized P/E of 24, which is relatively reasonable if you're optimistic about the future of these companies.

Shen: Exactly.

O'Reilly: Do you feel like they're kind of wedged between the American public, which can be fickle sometimes, and Hollywood coming out with a blockbuster or not?

Shen: Yes, that was something that a lot of the management teams of these companies commented on, basically saying that 2014 was a bit of a struggle because there frankly weren't that many big blockbusters.

O'Reilly: These guys sit around every day hoping for an Avengers to come out!

Shen: Exactly. Movies like The Amazing Spiderman 2 and some of the other tent poles that they thought were really going to do well over the summer ...

O'Reilly: They just didn't work.

Shen: Didn't work out as well as they had hoped. That's the position they're in really, where they just need Hollywood to be putting out the big movies that will bring in audiences.

I have to admit, though, that a lot of the management teams are bullish for 2015 because you have movies like Jurassic ...

O'Reilly: The Avengers 2.

Shen: Avengers, the new Star Wars movie.

O'Reilly: The Jurassic Park, yes. That looks awesome.

Shen: Exactly. A lot of them are bullish, and think their comparisons and their performance for 2015 will boost.

It's a mature industry. Obviously it's been around, like you said earlier ...

O'Reilly: 90 years!

Shen: Yes, 90 years, and generally have seen good growth. Some of the long-term issues that they might run into are declining attendance ...

O'Reilly: Yes, and I wanted to bring it around. I like my Netflix!

Shen: Yes, exactly.

O'Reilly: I have my couch. It's comfy!

Shen: Something that I thought was very telling was that younger demographics -- your teens, about 14-24 years of age -- in that demographic group they've seen double digit drops in attendance; I think 15-17% falls each year for the past few years.

O'Reilly: Wow.

Shen: A lot of people are trying to guess exactly why that is.

O'Reilly: What will happen there, yes.

Shen: I think it's just a matter of entertainment alternatives, like you mentioned.

O'Reilly: Because we can go to YouTube right now ...

Shen: Exactly. People are on YouTube, people have Netflix, Amazon Prime Instant Video. They have all these different entertainment options.

The window, also, from the theatrical release to the point where it's on video on demand or streaming has shortened considerably from the old industry average of 3-4 months. It's shrunk even beyond that.

O'Reilly: You can get it in 3-4 weeks with some movies, even faster in On Demand.

Shen: And like we mentioned previously, the rising ticket prices will dampen demand a little bit. I think it's just some of these alternatives, just changing views of how people consume entertainment. It's having some long-term effects.

At the same time, the theater operators, they're trying to combat that. They're trying to bring in audiences with upgraded amenities. Certain theaters have been installing, for example, the really nice reclining seating.

O'Reilly: That seems to be the only way to go for these theater operators. You need to go bigger, you need to go better, you need to have an IMAX screen. You need to have, what did you call it? The lounging chairs?

Shen: Yes, the reclining chairs. They're also offering in-movie dining options with full service bars, to attract people in their early 20s who tend to be spending well.

O'Reilly: A little more disposable income.

Shen: Exactly. Also expanded menu options and some of their loyalty programs, making it more convenient to order through mobile apps. They're trying to hit it through these different angles, to try and see that bump in attendance, especially in the key demographics.

O'Reilly: Given all the facts that we've discussed, which of these companies, if you had to invest in the industry, do you like?

Shen: I think that overall I feel pretty good about these companies' outlook. I know that they have these challenges, but I think it's an old industry -- and everyone loves movies. Some things can't be replaced, just watching it at home on your TV. You have to have that big screen experience.

O'Reilly: Well, and the current Hollywood business model still is release it on a couple thousand screens, then roll it into the homes, and that's probably not going to change.

Shen: Yes. One company that you had mentioned earlier that is an indirect play that has seen really good growth, is IMAX.

O'Reilly: Those screens are insane.

Shen: They're up 28% in the past year, their shares are. They're trading at about 30 times their 2015 estimated earnings. They have about 900 screens, 930 screens worldwide, but their big, big, big growth avenue has been China.

O'Reilly: Yes.

Shen: The thing is, they've done really well in partnering. They have partners in China that have allowed them to work through some of the restrictions there. For example, they will only allow so many foreign films to screen in the Chinese market.

O'Reilly: Oh, so they've been able to circumvent that?

Shen: They've been able to work with production companies there to play local films instead, so they've seen really good growth. 55% of all their screens are abroad, and they expect China revenues to be up 40%. With 234 theaters in China, they have 217 in the backlog in China as well; that's 55% of their total backlog.

You can see how that is a really big opportunity for them, and through some of their joint revenue sharing programs -- because when you get an IMAX screen, you either buy it outright through a sale, or you can do a lease essentially, where IMAX will share in some of the ticket sales or concession sales even. They've been able to work with some of the tighter restrictions there through their business.

O'Reilly: That's pretty sweet.

Shen: Yes.

O'Reilly: Very cool. I love what IMAX has done, but if I had to pick I'd probably do Cinemark because they just keep it simple. They just make their money showing movies. It is what it is.

Shen: Something else that I thought was interesting; it's a very small piece of Carmike's business, but I went to one of their theaters once and I realized that for certain locations they have found the best business is to play movies that are a few months behind. They have I think 10-15 theaters that do it that way.

It's just interesting how these theaters, seeing how some of their locations are struggling, they're trying to find new ways to boost the growth.

O'Reilly: Yes, I can think of several theaters like that near me that, $5-6, you can go see a movie a couple months after it comes out. Everybody wins because they obviously have to pay the studio less.

Shen: Exactly, and they still get their bread and butter through the concessions. Most of these theaters, about 2/3 of the revenue comes from actual admissions, and then 1/3 comes from concession, but their profit margin ...

O'Reilly: They get flipped there, totally.

Shen: Their gross margin on concessions is like 85% on average.

O'Reilly: Good lord.

Shen: Whereas for their actual ticket sales, it's maybe 45-50%, so very significant for them.

O'Reilly: Very good. Thank you for your time, Vince. Let's go to the movies!

Shen: Yes! What would you like to see?

O'Reilly: I actually don't know what's out right now. I was planning on seeing The Avengers, but I don't know.

Shen: Yes, but that's not out for some time.

O'Reilly: Yes. What's out right now? I don't know.

Shen: We'll think of something.

O'Reilly: We're too busy looking for Foolish stocks!

Shen: Exactly!

O'Reilly: That is it for us, Fools. Before we go, I wanted to make our listeners aware of a special offer available to all Industry Focus listeners for a subscription to The Motley Fool's top performing Stock Advisor newsletter. Head over to focus.fool.com to learn more about this offer.

As always, people on the program may have interests in the stocks we talk about, and The Motley Fool may have formal recommendations for or against these stocks, so don't buy or sell stocks based solely on what you hear on this program.

That's it for us, Fools. Thanks for listening, and Fool on!