Tuesday, March 02, 2010

Regal Entertainment Group (NYSE:RGC): Upgrading to Outperform; Raising Target to $19 - BMO Capital

BMO Capital is upgrading the cinema names this morning:

- Regal Entertainment Group (NYSE:RGC) is upgraded to Outperform from Market Perform while raising their target to $19 (prev. $15).

- Cinemark Holding (NYSE:CNK) is upgraded to to Outperform from Market Perform with target raised to $20 (prev. $18).

Since Regal (RGC) is the larger of the two names and has underperformed its peer Cinemark (CNK) by a wide margin over the past year, I think there will be a better trading opportunity in the latter.

BMO notes they are growing increasingly optimistic about 2010 films, believe the DCIP financing will yield shortand long-term benefits, and believe the stock is likely to see multiple expansion from digital and 3-D. They expect 2010 to be a watershed year for exhibitors as an expanded digital screen/ 3-D count, coupled with heightened consumer awareness of 3-D and event programming, leverages the swelling amount of 3-D Hollywood films and event programming. RGC should benefit nicely from the shift owing to its large market position and its 2009 success with 3-D. BMO's current forecast for RGC contemplates incremental profits from higher attendance and ticket prices associated with feature film and programming possibilities with digital screen/3-D capabilities (3-D, events, corporate meetings, etc.) but they believe investors will soon pay a higher multiple, because the shift is likely to result in noticeably improved and sustainable returns on invested capital.

Basis for the Upgrade
1.) BMO anticipates multiple expansion as the implementation of 3-D enabled digital projectors penetrates the worldwide theatrical screen base over the next three years. 3-D is clearly revitalizing the exhibition industry as consumers are frequently being provided a better movie-going experience (recession or no recession). BMO expects this to translate into marginally higher attendance (even if from the curiosity factor), higher ticket prices (virtually no pricing resistance, especially given that films can still be enjoyed in 2-D at traditional pricing levels), and higher operating income per ticket (even if margins come
down slightly on royalty/licensing payments for 3-D technology).

2.) They believe investors will start looking forward and ascribing a premium to the earnings potential in the 2010-2012 timeframe where digital projection and 3-D will play a larger role in the movie-going experience and revenue generating capability of ticket sales for Regal and others. The growing supply of event films in the 3-D format, which should be an ongoing benefit for the next few years, will improve theater level economics for the next three years.

3.) Regal expects to ramp up 3-D capable screens from its current 427 screen base in 308 theaters to 527 screens by the end of 1Q10 and to the 1,100-1,200 level by the end of 2010 (which seems low by its statements that it can be at the 150- 200 per month install level once DCIP funding occurs). This could help push 2010 earnings estimates to higher levels on the up-charge ability of 3-D films, which are expected to number more than 20 in 2010.

Management indicated it expects DCIP to close within the next couple of weeks. The basic terms of the financing include a five-year, $445 million facility, junior capital of a $135 million, and a combined equity contribution of $80 million from the three exhibitors (AMC, Cinemark and Regal). Regal’s share of the initial equity contribution will include a combination of its existing digital equipment and cash. BMO thinks RGC’s share will be close to $35 million in equipment and cash, a meaningful portion of which has already been spent, including the costs of silver screens. In addition to the initial capital contribution, contributions of approximately $5-$8 million per year during the three-year rollout period to cover any costs in excess of the amount funded by DCIP are expected. Investors will welcome the closure of the financing adventure DCIP has experienced.

4.) Strong results from NWSA’s Avatar and the overall results from Holiday 2009 films lead to carry-over benefits in the first quarter of 2010. The 2009 calendar box office finished up 19.3% year over year in the quarter and 10% in 2009 to a record breaking $10.6 billion. The success of NWSA’s Avatar and its $706.6 million earned at the domestic (North America) box office to date is in part responsible for the gains along with other Holiday 2009 films that have had strong theatrical runs such as The Twilight Saga: New Moon ($295.7 million domestic to date), The Blind Side ($247.4 million domestic to date), Alvin and the Chipmunks: The Squeakquel ($216.6 million domestic to date), Sherlock Holmes ($205.7 million domestic to date), 2012 ($162.3 million domestic to date), and A Christmas Carol ($137.9 million domestic to date).

Estimate Revisions
BMO is raising their 2010 EPS estimate to $0.82 from $0.76 and their 2011 estimate to $0.94 from $0.89. Firm's new 2010 EBITDA estimate is $573 million (up from $558 million) and their new 2011 estimate is $582 million (up from $568 million). The primary reason for their upward estimate revisions is that they believe improving sentiment over 2010 films and better definition to the digital screen and 3-D rollout.

Notablecalls: As noted above, CNK has been on tear lately while RGC has lagged performance wise. Now may be the time to play ketchup. 3-D is coming in a big way and is about to revolutionize the industry.

Note that the much famed Doug Kass over at TheStreet.com has grown very fond of the cinema operators of late and told his followers yesterday he sold some of his CNK to buy more of RGC.

It always pays to be in good company.

The stock isn't a huge mover but given the proximity of annual highs, that's where the price is headed. Could trade towards $15.50+ today.

PS: Note that Carmike Cinemas (NASDAQ:CKEC) posted strong results last night. Should add some fuel to the fire.

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