Is the Cineworld share price severely undervalued?

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Like many other leisure companies, Cineworld (LSE: CINE) has had an extremely difficult 18 months. Indeed, the chain has fallen to huge losses, while the already-large debt pile has continued to climb. This has strained the Cineworld share price, which is currently priced at 63p. Although higher than its October lows of under 30p, it is still significantly lower than its recent post-pandemic highs of over 120p. As such, is the current Cineworld share price undervalued or are the risks too large?

Trading update

Since its 2020 full-year trading update, the Cineworld share price has been on a downward trajectory. This is not overly surprising when looking at the results. Indeed, the company saw an operating loss of over $2.2bn, and revenues were also 80% lower than 2019.

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Following the trading update, one of my main concerns is the company’s large amount of debt. To survive, the chain has been forced to issue significant amounts of debt. This means that net debt has risen from an already high $7.1bn to over $8.3bn. This gives Cineworld an extremely high debt-to-equity ratio of around 2,000%. For a company unable to make a profit, this is clearly a worry, and leads to fears that it will not be able to survive.

The poor trading update has certainly been reflected in the Cineworld share price, which has fallen around 40% since.

Other issues facing the company

It is not only the trading update that has caused the decline in the Cineworld share price. For instance, there is the competition from streaming services, such as Netflix and Disney Plus. These have seen a surge in demand since the pandemic hit and may therefore limit the number of people going back to cinemas. The high number of coronavirus cases at the moment is also likely to strain demand.

The lack of current blockbuster films is another reason that may hinder Cineworld’s recovery. This has been particularly bad due to delays to both Mission Impossible 7 and the new James Bond. Nonetheless, the Bond movie is finally expected to arrive in September and a host of highly anticipated films are also expected in 2022.

As such, I feel that the lack of new films is a short-term problem, which should hopefully start to improve over the next few months.

Furthermore, there have been small signs that customers will return to the cinema. For instance, when Cineworld reopened in May, it stated that attendance numbers were “beyond [its] expectations”. This signals that there may still be sufficient demand for cinemas, even despite the challenges of both the pandemic and streaming services.

Is the Cineworld share price a bargain?

From a valuation perspective, Cineworld shares are not actually overly cheap. For example, it has a price-to-book ratio of around 7, which is relatively high. In comparison, other pandemic-hit stocks like National Express have a price-to-book ratio of around 1.2. This indicates a much cheaper valuation.

Accordingly, I don’t think that the Cineworld share price is low enough to justify taking on the risks. This does not mean that it will not rise though. In fact, the heavy shorting of Cineworld shares could lead to a ‘short squeeze’, similar to what happened with AMC. This was the reason why Cineworld shares rose 10% on Friday. Even so, this is not enough to tempt me to buy.

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Cineworld (LSE: CINE) became one of the main ‘reopening’ stocks on the London Stock Market. And the share moved from lows around 20p in March 2020 to a peak just above 120p this March.

The Cineworld share price has been volatile

But the path of the stock wasn’t straight up. And that’s not surprising given the challenges caused by the pandemic. However, the company’s screens finally reopened around the world during April and May.

Nonetheless, the share began to plunge in March and ended up more than 50% lower last week. And I reckon that move was directly related to the resurgence of Covid-19.

Since the start of the stock’s fall, it’s been emerging that economic recovery from the pandemic will likely be messy. So that big idea about investing in so-called ‘reopening’ stocks for a v-shaped recovery now seems flawed. Indeed, we’ve seen weakness in other reopening stocks as well, such as Saga, Go-Ahead and International Consolidated Airlines, among others.

In the case of Cineworld, I reckon investor sentiment turned against the company because of the perception that restrictions may continue or be reinstated.

But, on top of that, it’s still unclear whether customers will return to the big screen in previous numbers. And the film industry itself has been battered and less-productive. So there are fewer big new film releases to attract customers.

The stock’s been bouncing

Despite all those concerns, the share price staged an impressive bounce on Friday. Is that a signal to buy the shares? After all, contrarian investors would likely recommend buying stocks near their lows when the bad news is at its worst.

I’m not. It’s possible the stock could surge higher from where it is today. And the business could gain traction with a long and steady recovery.

But, to me, this isn’t a cheap share, it’s a stock with a damaged underlying business. So, rather than thinking of it as a reopening stock, I’d consider it a recovery situation. But I’m not keen on those.

Top investor Warren Buffett once said that, in his experience, “turnarounds seldom turn.” And that’s why he focuses on buying quality businesses at decent valuations.

A focus on quality and value

Meanwhile, Cineworld strikes me as a company struggling to keep the lights on as it juggles its finances. The battered business is a very long way from being a quality operation in today’s economic and pandemic-racked environment. Indeed, Buffett himself turned his back on the airline industry when the pandemic hit by selling his shares in the sector.

Right now, I’m cautious about most shares. It seems to me that the investor enthusiasm for reopening stocks is declining. And the reality of the economic fallout from the pandemic is beginning to bite.

So, for me, it’s even more important to focus on the enduring factors of quality and value in underling businesses. And to pick shares very carefully. Today, Cineworld doesn’t make my ‘buy’ list, despite the bounce in its share price.

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Cineworld Share Price

The Cineworld share price (LON:CINE) soared on Friday in a move that looks to be straight out of the AMC playbook. In the middle of the afternoon session on Friday, as the week draws to a close, the Cineworld share price is up by 9.53% to 62.78p per share. It follows a torrid month for the cinema chain which saw its share price tumble. At the time of writing, the Cineworld share price is down by 28% since the beginning of July. It appears as though the dramatic moves over recent weeks have been a result of short selling from major investors followed by a response from Reddit-type short squeezers.

Short Selling

It has been reported that 7.5% of Cineworld shares are being held in short positions by large investment companies. Short shellers have likely been attracted to Cineworld because of its significant debt of $8.3bn, as concerns remain over the strength of the recovery from the pandemic, and the cinema chain’s ability to cope.

However, the dramatic fall in the stock’s value caught the attention of other investors who have been able to buy Cineworld shares at a cut price. The mass buying also appears to be an effort to squeeze on the major investment managers, in a similar vain to previous Reddit-induced shorts.

Analysts’ View

Earlier this week Peel Hunt, the specialist for UK investment banking, confirmed its is maintaining its ‘hold’ recommendation. However, it did reduce its price target by 10p to 75p per share.

“The Cineworld share price has drifted off since the highs of March, when it reached 120p, more sharply recently,” Peel Hunt said.

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While the cinema has performed reasonably well in the US and UK as restrictions have been lifted, the precariosuness of the recovery remains an issue, as does the threat of streaming services to the industry.

Investors will be keeping an eye on the Cineworld share price over the coming days to see which way things go.

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