Last month the UK government unveiled its new roadmap to ease lockdown restrictions in England, and the Cineworld (LSE:CINE) share price has exploded. In fact, the stock price has been climbing rapidly over the last four months, rising by around 250% since November last year.
As the vaccine rollout continues, it seems to me that investors are gaining hope for a return to normality later this year. And with a lot of pent-up demand, as well as a long list of delayed blockbuster movies waiting to be released, the cinema industry could soon be returning to its former glory.
But I’m not going to be adding the shares to my portfolio any time soon. Let me explain why.
Can the Cineworld share price recover?
Under the lockdown roadmap, cinemas and other indoor entertainment facilities will be reopening in early summer this year. Needless to say, this is fantastic news. But remember, Cineworld is an international business. And only cinemas in Britain are allowed to reopen under this plan.
However, the management team appears to be reasonably confident. In fact, its entire bonus scheme for the next three years is directly linked to the stock price’s performance. This acts as an incentive to get the business back on track and aligns management’s interests with shareholders — something I like to see.
Furthermore, the Bank of England has revealed that the household savings ratio (household savings as a proportion of disposable income) has risen from 9.6% to 29.1% in the first six months of 2020 alone. So economists are predicting a significant boost in consumer spending as lockdowns are lifted. Combining increased savings with the aforementioned pent-up demand certainly makes me believe a large number of people will return to enjoy the big screen experience.
But this is a best-case scenario. It’s quite likely that many individuals will not be comfortable enough to go to the cinema right away. That’s especially when streaming services such as Netflix or Disney+ offer a much safer experience at home.
Debt levels are rising
Cineworld had to secure additional debt financing to remain afloat in 2020, and its share price has suffered for it. Usually, this wouldn’t be a significant issue, except the stock had a monumental amount of debt beforehand.
For years, Cineworld has employed an acquisitive growth strategy. Meaning it uses debt to fund the acquisition of cinemas to expand its portfolio. Today, the chain is the second largest in the world, with over 790 locations. The strategy certainly achieved growth, but it failed to create value.
In 2019 the firm had around $7bn of debt. Of the $725m operating profit generated that year, $499m was gobbled up by interest payments alone. Since then, the total debt level has risen even further towards $8.5bn. Even if Cineworld successfully returns to its pre-Covid operating levels, almost all of its profits are going to evaporate to cover interest payments. Consequently, there will be very little left to reduce debt levels, reinvest in the business, or return to shareholders.
And that, to me, is a deal-breaker, especially since there are many other fantastic businesses out there. So personally, even though the Cineworld share price could continue to rise this year, I won’t be buying the shares.
