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50% Upside And A 3.4% Yield From This Industry Leader

Thursday, February 27, 2014 - 10:00am

Based on a lot of the talk these days about people's moviegoing habits, you might get the impression the cinema industry is barely surviving.

Granted, the industry's best days may be behind it, thanks to hot competition from the many on-demand forms of video entertainment now available like Netflix (Nasdaq: NFLX), Roku (which may be going public sometime this year), tablets and mobile devices. But cinemas are far from dead.

In fact, the industry is still growing -- and quite briskly in some parts of the world.

Growth in the mature U.S. market will probably remain tepid, though, with industrywide revenue expansion of 2.3% in 2014, projects Australian research firm IBISWorld. That's a touch slower than the 2.5% growth rate of 2011 through 2013.

Latin America, on the other hand, has an especially robust movie theater industry with annual revenue growth in the 8% range. What's more, this region should see much better growth at the box office for years because its middle class is expanding. As overall prosperity keeps rising, even more Latin Americans should be able to afford regular trips to the movies.

This presents a particularly good chance at profits for one movie theater company with large domestic and international operations. This Plano, Texas-based company currently has about 330 cinemas with 2,600 movie screens in the U.S. and 170 theaters with more than 1,300 screens in a dozen Latin American countries. Management is smartly focusing expansion efforts on Latin America and plans to open 117 new theaters in the region during the next three to five years.

I'm referring to Cinemark Holdings (NYSE: CNK), a stock I think can deliver solid growth and attractive income in coming years.

I prefer CNK to main rivals like Regal Entertainment (NYSE: RGC) and Carmike Cinemas (Nasdaq: CKEC) because its far larger emerging markets presence provides a more diverse revenue stream, as well as greater exposure to faster growth. Carmike, for example, has about 250 theaters with 2,500 screens all in the U.S. Of Regal's 580 theaters with 7,400 screens, virtually all are on the U.S. mainland, with a few located in Guam and American Samoa.

Flickr/Nicholas Eckhart
While most major movie companies are adopting newer technologies that enhance sound and picture quality, Cinemark has been a leader in this regard. The company should have digital projection capability in all its U.S. theaters by the end of the year.

That's not to say CNK lacks a domestic growth strategy. Management always seeks selective acquisitions of profitable U.S. competitors and completed a $240 million buyout of Dallas-based Rave Cinemas last May. The deal resulted in 32 more theaters with 483 screens and added significantly to CNK's New England footprint. The buyout fit well with the firm's philosophy of sticking mainly with mid-size suburban and metropolitan markets that are generally less competitive and more likely to generate high, stable margins.

While most major movie companies are adopting newer technologies that enhance sound and picture quality, CNK has been a leader in this regard. The company should have digital projection capability in all its U.S. theaters by the end of the year, totally eliminating their reliance on traditional film and the associated disadvantages (for example, progressively worse sound/image quality with each showing and the risk of breakage mid-movie). Conversion of CNK's international theaters is well underway, too, with close to half now switched to digital.

For several years, the company has been providing deluxe theaters with wall-to-wall, ceiling-to-floor screens, luxury seating and 3-D capability (another technology CNK has been especially quick to adopt). Such theaters, which are geared toward those willing to pay a premium, currently make up a relatively small portion of overall capacity, perhaps a few hundred screens. However, management says it plans to make them a regular part of future domestic cinema complexes.

Another potentially profitable innovation for CNK is Movie Bistro, cinema eateries introduced in the summer of 2013 that let customers dine while they watch a movie. In addition to hot dogs and other traditional cinema fare, the eateries offer higher-quality menu items, microbrews and premium wines. There are currently only a handful of Movie Bistros, mainly in Texas, so it remains to be seen if the concept will take off in a big way.

Risks to Consider: Having a large presence in Latin America exposes CNK to the risk of unfavorable exchange rates. Extreme weakness in Latin American currencies could severely damage profitability.

Action to Take --> Consider buying CNK. It's a strong stock in a tough industry. Despite interest rate risk, analysts project CNK will grow earnings per share (EPS) by 15% a year for the next five years. This implies roughly 50% upside for the stock price during that time, to $44 from $29 currently, based on trailing EPS of $1.28 and a historical price-to-earnings (P/E) ratio of 17.

CNK's $1-a-share dividend is good for a 3.4% yield at its current price. I'm confident the firm can maintain a similar yield in coming years based on a history of strong dividend growth (the payout has tripled since the stock began paying a dividend in 2007), a sound strategy for future growth, and a sustainable payout ratio of about 60%.

P.S. Investing doesn't have to be complicated. If you invest in simple businesses that dominate their industries and return massive amounts of cash to their investors, you stand to make a killing in the market over time. It works. In fact, the stocks in our latest report, "The Top 10 Stocks For 2014," have delivered a total return of 237% over the past five years following this simple strategy. To learn more about our top picks for 2014 --including several names and ticker symbols -- click here.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.