A massive turnaround story or just another value trap?

How can you not love AMC?

Company background

AMC is the largest movie exhibition company in the United States, the largest in Europe and the largest throughout the world with approximately 1,000 theaters and 11,000 screens across the globe. The company was founded back in 1920 and is headquartered out of Leawood, Kansas. AMC is internationally recognized as one of the oldest and most meaningful players in the global entertainment industry. To get a better sense as to how popular the brand is one should look at the total annual attendance numbers back in 2019, before the COVID-19 pandemic devastated the industry. The company saw over 356 million people visiting their AMC theaters throughout the fiscal 2019, which just shows the magnitude of their operations and client base. Of course, there is a reason as to why AMC has managed to hold the number 1 spot in its respective industry for so long and it is associated with their client-oriented approach and attention to detail, which focuses on the guests and providing them with the best-possible movie-going experience.

Innovation has been embedded into the core spirit of the company ever since its foundation and AMC Entertainment has always focused on breaking the stereotypes, barriers and limitations that other see out there. It all started when the son of one of the original owners returned from serving in the army and took over a successful Midwestern family business. Stanley Durwood saw one screen in one building as limiting. People wanted more choices. So he began remodeling several large single-screen Kansas City, Mo. theatres into smaller buildings with multiple auditoriums. The result? The first multiplex theatre in the world was born. The success was massive, and the theatre served as a blueprint for the industry. By 1968, Durwood’s multi-screen theatre chain had expanded nationwide and was incorporated as American Multi-Cinema, Inc. (AMC).

During the following three decades of Durwood’s leadership, AMC continued to innovate with the movie-goer in mind. The armchair cup holder, stadium seating and the industry’s first rewards program continued to revolutionize the cinema industry.

That innovation continued into the 21st century, as AMC was on the cutting-edge of innovation through the co-founding of online ticketing, circuit-wide gift cards, a groundbreaking partnership with IMAX, the launch of AMC Stubs rewards program, and the introduction of AMC Dine-In Theatres. AMC also greatly expanded its footprint in North America through the acquisition of Loews Theatres and Kerasotes Theatres. Backed by its majority shareholder, The Wanda Group, AMC led the charge on the instillation of plush, power recliners, massively expanded and improved food and drink options for guests, including the introduction of MacGuffins Bars, and Coca-Cola Freestyle machines, and has made movie-going more immersive than ever through an expanded partnership with IMAX and the introduction of Dolby Cinema at AMC.

Current position – Financial Performance & Future Growth prospects

The part of the entertainment industry that requires for people to go out of their home and physically visit locations, venues, arenas, theaters etc. has been basically annihilated throughout the last 12 months by the COVID-19 pandemic, which shook the entire world in 2020.

As of March 18, 2020, all AMC theaters were temporarily closed because of the COVID-19 pandemic, however, the company reopened a majority of its theaters on August 20th, 2020. Furthermore, on July 28th , 2020, AMC Theaters also signed on “a multi-year deal” with Universal Pictures on releasing new films on VOD streaming after three weekends. This was a huge accomplishment for AMC as viewing on demand and online streaming are the two biggest threats for AMC’s business model. By securing a 3-week window before new releases become available on demand, AMC has managed to protect the movie-going experience and keep it relevant as an adequate and viable option for movie lovers.

When we leave the great deal with Universal Pictures aside, for a moment it seemed that everything that could be going wrong for the company back in 2020 was indeed doing so. It is understandable that being forced to shut down its operations and close down its locations is an unpleasant experience for any business, but what really determines how well a company goes through an unpleasant time like that and whether or not it ever comes back from it is the actual financial stability of the company.

Since 2017, AMC’s interest expense has exceeded operating profit, which just shows how massive the debt burden for the company was even before COVID-19 hit. AMC was also among the companies heavily affected by the Financial Accounting Standards Board rule change last year that reclassified operating leases as debt. That modification led to a significant increase in the debt levels for the company and made it even more complicated to calculate the already difficult financial metrics used to compare businesses. The company started feeling the real burden of those contractually obligated lease payments after COVID-19 shut AMC’s doors, as these monthly payments went from a hypothetical debt burden to a very real one overnight. In August, AMC said it reached agreements with landlords to “defer or abate rent” on about 75% of its 900 leases.

While the company has taken steps to boost liquidity over the past year, it still has a highly leveraged balance sheet. At the end of Q3, the company had just $417.9 million in cash and $5.8 billion in debt.

We must say that AMC Entertainment and its CEO Adam Aaron have been fighting tooth and nail for the survival and preservation of America’s favorite movie theater chain. Many financial, business and strategic steps were taken throughout the last 12 months in order to provide AMC with more breathing room. The list of all of the company efforts for staying alive in 2020 is presented below:

  • Took another $325 million under existing revolving credit facilities.
  • Issued $500 million of 10.5% first-lien notes due 2025.
  • In July, successfully completed a debt exchange offer, which:- Reduced principal amount of debt by $555 million;- Reduced cash interest expense by $120 million in the first year following the exchange offer;- Extended maturities on approximately $1.7 billion of debt until 2026; and- Included issuance of $300 million of new 10.5% first-lien notes due 2026.
  • In September, the company launched an at-the-market (“ATM”) equity program to sell up to 15 million shares. This raised approximately $56.1 million. A month later, the company’s diluted shareholders gained by selling an additional 15 million shares. The two ATM offerings raised $97.7 million for the company.
  • In January, the company completed another ATM offering of 63.4 million shares to raise 304.8 million. And the $917 million the company recently announced was raised through another stock offering ($506 million) as well as $411 million line of credit that AMC took out through its European subsidiary, Odeon.

Following the most recent $917 million cash infusion from investors, AMC has managed to avoid bankruptcy once again with this last minute rescue. The company’s CEO Adam Aaron took the opportunity to inform investors that bankruptcy is off the table for the entire 2021:

“Today, the sun is shining on AMC. After securing more than $1 billion of cash between April and November of 2020, through equity and debt raises along with a modest amount of asset sales, we are proud to announce today that over the past six weeks AMC has raised an additional $917 million capital infusion to bolster and solidify our liquidity and financial position. This means that any talk of an imminent bankruptcy for AMC is completely off the table.”

While AMC’s efforts for raising capital and re-structuring its business operations could be applauded as the company has raised more $1.3 billion since September, one must not forget that this has come at the expense of diluting shareholders as the share count has grown by more than 225 million. Furthermore, the amount that the company has raised will provide some short-term breathing room, but will definitely not do much in the grand scheme of things. The main reason for that is associated with the large quarterly losses that the company has been reporting – AMC recently lost $900 million in the third quarter, even as more cinemas reopened. Additionally, the movie theater chain also saw its cash burn rise to $324 million in the third quarter. This is up from $292 million in the second quarter as the company continues to struggle with limited seating capacities and tighter restrictions in some states and countries.

As a result of the presence of vaccine options, many analysts, investors and commentators are now looking at the COVID-19 pandemic as if it is almost done and that we are basically out of the woods. This type of beliefs goes even further in suggesting that the moment the vaccines kick in on a global level, then the economy would be back to its pre-COVID level of productivity, consumer spending, unemployment rate etc. Well, we believe that this is an extremely ignorant and uneducated way of looking at the way that COVID-19 devastated the global economy, increased both the personal and corporate indebtedness to levels unseen ever before and also contributed greatly to the extreme widening of the wealth gap. We believe that it would take at least 12-24 months for the global economy to fully recover from this massive hit, and that is if we manage to avoid falling into a severe debt crisis in the meantime. The latter depends on how skillful the Federal Reserve and the US Government will be in implementing a well-coordinated and balanced Monetary and Fiscal support to the US economy. The Fed’s main goal should be not to continue to buy financial assets forever, as this doesn’t necessarily do much for creating economic productivity, but rather to come up with various modern market theories (MMT) for injecting cash into certain specific parts of the real economy in a coordinated and carefully calculated effort together with the US Government.

This way this story unfolds is of significant importance for companies like AMC Entertainment. As even if we accept that we will be moving beyond the pandemic in Q2 and Q3 of this year, theater attendance seems unlikely to reach 2019 levels until at least 2024 or even later down the line. This, of course, is a big area of concern for the company as it needs to start generating revenues to pay off its massive debts and growing interest.

From a valuation standpoint we believe that looking at a metric like the Price-to-Sales ratio for the company could provide us with somewhat of a general view as to where does AMC currently stand and where is it headed next. The expectations are for a slow but progressive increase in sales numbers, which will further normalized the otherwise very reasonable P/S ratio of AMC. The company is trading at a current market cap-to-trailing twelve months sales of 1.98 times. This does not appear unreasonable. There is a good chance of the company surviving, as mentioned above, and pricing our analysis forward on two years of sales at least recognizes its prospects as a business as there is no proof that the company is completely obsolete. The argument that the massive success of Netflix (NFLX) does make AMC irrelevant, is the same as saying that EA sports make real-life sports irrelevant. In fact, industry revenues have climbed since the trough in 2Q2020, and AMC’s revenues have also climbed in sync.

The “Reddit” phenomenon

We have been talking for months now about the fact that the retail trading force in the market has seen a remarkable increase in numbers, volumes and participants throughout the last 12 months and we have been warning about the potential long-term implications that this could have on the stability in the financial markets as well as on the overall respective volatility that we are seeing each and every day. Up until now, the retail trader as a market participant has never been able to affect the price movements in the market due to the insignificantly low amounts, sizes and volumes that he/she usually trades. However, this is no longer the case as the January retail trading frenzy in the stock market and the ridiculous volumes and price increases on stocks like Gamestop, AMC, Bed Bad & Beyond and Blackberry showed exactly how powerful retail traders could be if they act together in unison with one another.

The whole thing started with the creation of a thread on Reddit, called WallStreetBets (WSB), where retail traders got together and decided to start buying some of the most heavily shorted stocks out there in order to push the prices of these stocks higher and force the large hedge fund managers to start covering their SELL positions and thus effectively creating what is known in the market as a short-squeeze. Short-squeezes are nothing new in the market as we have plenty of examples from the past where traders were caught on the wrong side of a short position. What was new this time around though was that the short-squeeze was initiated by over 8.5 million retail traders communicating openly in the WSB group on Reddit, in a coordinated and organized effort in the market. While 1 retail trader is not powerful enough to move the market as a result of the low liquidity that he has access to, 8.5 million small accounts acting as one can easily become a formidable force in the market.

The retail push was so powerful that it caused AMC’s stock to move up from $2 up to over $20, thus registering the staggering 900% increase in less than 2 weeks. However, AMC’s case was actually not the only case of crazy stock price fluctuations as stocks like Blackberry Limited and Gamestop went up by 346% and 2758% respectively.

As you can understand, this bullish momentum could not have been kept on for very long as such massive short-term rallies are usually very vulnerable and fragile, which tends to lead to volatile reversals and strong and quick declines. Furthermore, let’s not forget that retail traders (non-professionals) are characterized as traders that usually have poor risk and money management skills and that are generally unable to control their emotions in the market, which is technically a recipe for disaster when working in such a volatile environment. Thus, we saw heavy retail buying interest across a wide range of prices for AMC and all of the above-mentioned highly speculative stocks that were part of the massive short-squeeze that occurred in the market. The powerful fear of missing out (FOMO) phenomenon led uneducated traders and investors to pile on the long side of the trade disregarding important investment rules and concepts like capital allocation strategies, diversification, risk management etc. As a result, we saw strong bearish reversals across all of these stocks at the end of January and in the beginning of February. In the case of AMC Entertainment, the stock lost over 65% of its market cap in just 4 trading sessions, dropping from $20 all the way down to $7. While prices and volumes have somewhat stabilized, we definitely don’t think that the retail driven volatility in the market is over, thus we would like take this opportunity to warn our followers to exercise extreme levels of caution in February. Any major rally for the stock into the $11-15 range will most likely be heavily sold, with a potential Double Top formation occurring on the Daily chart later in the month. The current price of $7/share is way too high and unjustified from a financial and business performance standpoint, thus investors need to be very careful with any long exposure that they have on the stock for now and should be looking for opportunities to book in any profits if they haven’t done so already.

Dow Theory 2.0 – Correlation Confirmation

Dow Experts’ approach has always been based on identifying the next great movement in the market by analyzing both the fundamentals, the technicals and all-important factors that have an impact on the price. Furthermore, our cross-correlation analysis allows us to act in the market only if the movement on the chart is confirmed by the other key ETFs and indices that we use in our investing philosophy.

As you know, the Dow Theory 2.0 includes more than 30 correlations between different ETFs and stock market indices, which give us a chance to confirm whether a certain movement in the market is worth taking action for.

Therefore, in order to determine whether AMC Entertainment (AMC) is a good stock to buy with respect to the current levels of the price and the future growth prospects, we have decided to analyze the performance of both the IWN (iShares Russell 2000 Value ETF) and the XLY (Consumer Discretionary Select Sector SPDR ETF). The two ETFs share a very strong and positive 83% 10-year correlation, which would allow us to confirm some of the signals that we are getting with a great deal of certainty.

IWN

IWN tracks an index of US small-cap-value stocks. The index selects value stocks from a universe of stocks ranked 1001-3000 by market cap. IWN offers a traditional value fund at a very low all-in cost. The fund’s large basket favors the smallest firms, with minimal spillover into midcaps, and typically carries a bit more risk and slightly less dividend yield relative to the midcap-biased benchmark. The index relies solely on price-to-book to identify value stocks, while most competing funds use many additional metrics. Still, comparison of style data points across ETFs is affected by the parent universe as well as the style metrics. In all, IWN offers solid value exposure to small-caps. The fund’s expense ratio is higher than some competing funds, but its excellent index tracking offsets the additional cost. It’s cheap to trade in any size thanks to massive daily volume. All-in, IWN is typically cheaper to hold and to trade than VTWV, which tracks the same index. IWN provides low-cost, solid coverage of a space that lacks a hard and fast definition.

The technical picture on the daily chart for the IWN ETF shows a significant over-extension to the upside as the ETF has appreciate with over 50% from the levels that it was sitting at last October. The upward sloping diagonal uptrend resistance capped the most recent rally at the end of January when the ETF was rejected around the $145 all-time highs. Following the decline towards $138 the price has been trying to rebound and stage a comeback, but the volume and the relative strength of this move have been quite weak, which in turn should be a warning sign for the bulls. The RSI is also about to confirm a strong divergence on the Daily chart. We are currently observing a very interesting and dangerous pattern occurring in the market, while the number of market uncertainties continues to rise we are seeing the general level of complacency among most of the market participants also rising. This could be easily seen in the increased borrowing of the cheap credit that central banks provide as well as in the heavily inflated prices of financial assets. It seems that everybody has this intrinsic belief that nothing bad can happen for as long as the Fed continues to print more money, thus keeping the liquidity in the market flowing. However, this sounds troubling as basically that is exactly what the definition of a bubble states. One of the most successful investors of the last century, George Soros defines what a “bubble” is with the following statement – “Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend.”. In our current economic environment, the underlying trend is the worsened economic environment as a result of COVID-19 and the misconception related to that trend is that the Federal Reserve can print us out of problem. This is a dangerous game and ETFs like IWN could be exposed the most to a potential strong reversal as a result of the nature of the companies that are part of the ETF – higher risk, speculative, small caps, which in some instances have relatively unstable financial performance. With that being said, we want to clarify that we are not bearish on the ETF in the long-term but we are informing you that if a broad market downturn occurs, ETFs like IWN will be hit the hardest.

Our downside targets for the ETF are $133 and $115 respectively, where we expect IWN to find a lot of buying interest, which in turn will result in the resumption of the long-term bullish trend.

XLY

XLY tracks a market-cap-weighted index of consumer-discretionary stocks drawn from the S&P 500.

XLY is a portfolio of US large-cap consumer-discretionary stocks. XLY’s basket of stocks represents the sector well, despite concentration in the largest names. As a part of the Select Sector SPDR suite, the fund pulls its holdings from the S&P 500, which differs from the broad-market universe used by competing funds in that it excludes small-caps and most midcaps. The resulting basket contains just a fraction of the names held by our more diverse benchmark, however, industry biases are small and XLY tends to provide market performance. The fund’s average market cap is higher than our benchmark’s, but overall XLY provides solid exposure.

Some of the Top holdings of the XLY ETF are: Amazon.com Inc. (21.80%); Tesla Inc (17.83%); Home Depot Inc (8.21%); McDonald’s Corporation (4.30) ; Nike Inc (4.18%).

By looking at the daily chart, we can see the strong bullish rally that has occurred in the last 3 months taking the price from the October 30th lows of around $141 to the $173 all-time highs registered in the beginning of February. Throughout this most recent strong 22% rise of the ETF we have observed a consistent weakening of the bullish momentum, clearly portrayed by the lower highs put in by the RSI, thus creating a strong daily divergence between the price and RSI charts. This could easily be considered as an important warning sign for the bulls and that they might want to start booking some profits at the current all-time high levels. All US indices and ETFs are heavily overstretched to the upside and there is way too much uncertainty out there when it comes to how exactly will the COVID-19 pandemic play out in the coming weeks, as new and more contagious strains of the virus continue to emerge in different parts of the world. Furthermore, it is still not absolutely clear how efficient are the current vaccines in treating the new strains. This could potentially be a huge risk for the markets as the strict lock-down measures are expected to be lifted in the coming weeks and months as the general idea circulating in the media is that things are gradually improving now with the vaccines being distributed globally. However, things might not be as straightforward and further complications could arise as a result of the mutation of the virus, which could in turn have a devastating impact on the global financial markets. Most market participants look very complacent at the moment, with full and blind confidence in the power of the central banks to print their way out of this economic recession. However, as financial professionals with decades of actual market experience we know that this is simply not possible as you can’t print out growth, consumer spending, job creating, productivity etc.

The technical picture on the daily chart for the XLY ETF shows a significant over-extension to the upside as the ETF has appreciated with over 22% from the levels that it was sitting at last October. The upward sloping diagonal uptrend resistance capped the most recent rally at the end of January when the ETF was rejected around the $173 all-time highs. Following the initial decline towards the 50 DMA at $161 the price has managed to rebound and come back to the $173 ATH resistance zone, but the volume and the relative strength of this move have been quite weak, which in turn should be a warning sign for the bulls. The RSI has already confirmed a strong divergence on the Daily chart, as 3 consecutive lower highs have been printed. Furthermore, the price chart is also very close to complete a major Double-top reversal pattern on the Daily chart.

We are currently observing a very interesting and dangerous pattern occurring in the market, while the number of market uncertainties continues to rise we are seeing the general level of complacency among most of the market participants also rising. This could be easily seen in the increased borrowing of the cheap credit that central banks provide as well as in the heavily inflated prices of financial assets. It seems that everybody has this intrinsic belief that nothing bad can happen for as long as the Fed continues to print more money, thus keeping the liquidity in the market flowing. However, this sounds troubling as basically that is exactly what the definition of a bubble states. One of the most successful investors of the last century, George Soros defines what a “bubble” is with the following statement – “Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend.”. In our current economic environment, the underlying trend is the worsened economic environment as a result of COVID-19 and the misconception related to that trend is that the Federal Reserve can print us out of problem. This is a dangerous game and ETFs like XLY could be heavily exposed to a potential strong reversal as they investors have overcrowded the long trade. With that being said, we want to clarify that we are not bearish on the ETF in the long-term but we are informing you that if a broad market downturn occurs, ETFs like XLY will be hit hard.

Our downside targets for the ETF are $156 and $145 respectively, where we expect XLY to find a lot of buying interest, which in turn will result in the resumption of the long-term bullish trend.

Conclusion

After analyzing carefully both the fundamental and technical picture for AMC Entertainment, we conclude that due to the excessive amounts of debt, higher interest expense than operating profit numbers, close to bankruptcy filing position the stock is a highly speculative investment. With that being said, some of the metrics that we looked at like P/S suggest that the stock might not be as overvalued as everyone thinks. Furthermore, if the world does indeed officially defeat COVID-19 throughout Q1 and Q2, the company might start seeing a substantial improvement in its monthly and quarterly revenues, which in turn will help them with covering their debts. Additionally, the most recent round of capital raising has secured the financial existence of the company for the next 12 months, thus investors could at least take that negative scenario out of their equation. However, we tend to stay away from companies with highly-leveraged balance sheets as these high debt levels are negatively correlated with the future potential growth of the company. When you invest in a stock you tend to have a forward-looking approach for the next 3-5 years. Looking at the most likely trajectory of the monetary policy of the Federal reserve over the next 5 years it will definitely include certain tightening measures like raising interest rates. When interest rates rise, companies like AMC with high amounts of debt will have an even tougher task of repaying their debts, which will eat away from their growth.

Our individual stock analysis showed that another major move lower could be expected in the coming weeks, as a result of the high volatility in the market at the moment, primarily caused by the retail trading community. However, we at DowExperts always look at our specifically designed and built correlation confirmation matrix in order to either confirm or reject the findings of the individual stock analysis. What we found after looking at the IWN and XLY ETFs is that they are also signaling for a potential pullback in the coming weeks. This gave us further confirmation for our prior findings and solidified our bearish view on AMC. In case, you are inclined to go with the major turnaround story and the overall recovery of AMC’s business, then the recommended accumulation (buy) zone for any contrarian long-term investors would be between $3.50-$4.50/share. If you purchase the stock at a higher level, you would be paying a premium for AMC, that is currently unjustified and unwarranted. We believe that a purchase within the above-mentioned accumulation zone, could bring anywhere between 40-60% return within a 12-18 month period.


Sincerely,

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