Investment Analysis: Cineplex Inc.

Cineplex Inc. is a film exhibition company from Canada. The entertainment company has theatres for digital films in ten provinces. Its business diversification encompasses gaming, online merchandising of entertainment content, food services, and alternative programming. The company owns and runs several other brands such as Poptopia, Outtakes, and UltraAVX. In the year 2003, Cineplex Inc. was almost going bankrupt but merged with Galaxy Entertainment to avoid that path. Since then, it has been important for the company to take measures in analyzing its operations to avoid such a path in the future.

Cineplex’s Altman Z-Score (2013 and 2014)

One tool applicable in the pursuit of avoiding such situations is monitoring its Z-Score. The Z-Score is a tool that came to life courtesy of by Edward Altman in the 1960s. It helps in explicitly addressing the possibility of a company ending up bankrupt. In the last 12 years, Cineplex has had a minimum Z-Score of 1.08 and a maximum Z-Score of 91.85. The interpretation of Z-Score readings exists in three categories: less than 1.81, between 1.81 and 2.99, and over 2.99. The three divisions represent the Distress Zone, Grey Zone and Safe Zone, respectively. Cineplex Inc. had a Z-Score of 2.75 on December 2013 and 2.66 in December 2014 (GuruFocus LLC, 2015). Both marks are on the higher limits of the Grey Zone. The above implies that Cineplex is in some financial stress. A score below 1.81 means a bankruptcy situation is looming around.

Expanding Credit to Cineplex

The Z-Score is a financial indicator applied by investment professionals to predict instances of serious distress as far as the financial standings of various companies are concerned. It is a number that gives a summary of the financial strength of a company from five different perspectives. Some of the dimensions sized up include the working capital, pre-interest earnings, retained earnings, taxes, and market and book value of the liabilities and assets. The best thing about the Z-Score is that it removes all the complications involved working from all those perspectives by giving investors a single number to consider. Ideally, the Z-Score is a kind of grade that helps in determining the strength or shakiness of a company in the future.

However, the interpretation of the number has changed a lot since the first application of the Z-Score technique in the late 1960s. Initially, every company in the distress zone (below 1.81 in the Z-Score) was a no go zone for the investors. However, according to the provisions by the technique’s inventor in the recent years, most investment concern should be an issue for companies with a Z-Score of less than zero (negative). The Z-Score for Cineplex Inc. as at December 2014 was 2.66. The above that the company is currently in the Grey Zone. According to the provisions of the older Z-Score analysis, current investors would not be advised to expand their share in the company. However, as a bank providing financial credit to Cineplex Inc., expanding the credit would not be an enormous problem.

The first reason is that in the company’s history, the lowest Z-Score ever recorded was 1.08. With respect to the fact that it has never been on the negative, it means that the company’s creditworthiness is still good. Additionally, with the December 2014 Z-Score at 2.66, it stands out as an improvement. Extrapolating a graph of the Z-Score shows that Cineplex Inc. is will leave the Grey Zone soon for the Safe Zone. It has been gradually improving the Z-Score from 0.06 in December 2006 to the current 2.66 in December 2014. From the above, extending credit to the company harbors no risk as far as the situation in the foreseeable future remains constant.

Purchasing Cineplex’s Existing Debt

The issue of purchasing an existing brand is very particular. The specificity of the problem is because the management of a company critically takes into consideration factors such as the cost of the risk as well as the security intrusion. The basics of the Altman Z-Score are established in the period, the loss amount and the confidence level. As an investor, purchasing the debt of Cineplex Inc. is advisable. The above conclusion finds basis upon a couple of rationale observations.

To start with, the current Z-Score of Cineplex is almost entering the Safe Zone (where risk is at its lowest). In addition to this, historical observations indicate that for a company that is not operating in the financial sector, bankruptcy cannot happen without warning. Unpredictable adverse occurrences happen with a given level of consistency. Ideally, the worst case scenario is that the company may fall back to the Distress Zone in a year and then take two more years to fall bankrupt. Even in such a situation, three years is quite a long time to develop new working strategies.

Another reason for supporting the purchase of the Cineplex’s debt is history-based. Back in the year 2003, Cineplex was on the brink of bankruptcy. However, Galaxy Entertainment merged with the company that led to such a good performance that it even went public. Because Cineplex is currently not facing bankruptcy challenges, purchasing some of it debts would not be such an enormous risk. The worst that can happen is temporary stagnation of growth, but as soon new strategies are employed through the influence of the debt’s buyer, it would definitely be a productive venture.

However, it would be important to pass some conditions before the purchase of Cineplex’s debt. The company should first issue all its financial records, especially all used in the calculation of the Z-Score. The company should also be able to disclose other vital information such as the discount rate and the growth rate of a company. The above is important for the investor who is purchasing the debt for use in determining the company’s rate of equity return for the period under which the acquired debt will be outstanding.

Market Assessment of Cineplex’s Steady State Return on Equity

The growth rate in most companies primarily refers to the future EPS (earnings per share) growth rate. To calculate the growth rate for 2014, we require the EPS for 2013 and that of 2014. Cineplex Inc. reported an EPS of 1.41 at the end of the year 2013 and an EPS of 1.48 at the end of 2014 (PricewaterhouseCoopers, 2015). The growth rate thus is calculated as a percentage change of the difference between the two years, using year 2013 as the denominator. Therefore, it is (1.48 – 1.41) / 1.48 * 100 which comes to 4.73%.

Additionally, return on equity, as indicated in the financial statements of Cineplex at the end of year 2014, was 17.23% (GuruFocus LLC, 2015). The difference between the two figures means that much of the equity returns must have been ploughed back to the company mostly for purposes of market expansion. Apparently, according to the quarterly reports, Cineplex had made quite some commendable growth in several of its ventures. The total revenues had already increased by over 7% in the second quarter already (Cineplex Inc., 2014). That surfaces as an indicator of growth in the company’s market. With such a steady return on capital, the company was  able to increase its EPS. In addition, it retained a relatively significant amount to re-invest in the pursuit of taking advantage of the favorable market conditions that led to it’s the high return on equity in the first place.

References

Cineplex Inc. (2014). Second Quarter 2014 Report. Toronto: Cineplex Inc.

GuruFocus LLC. (2015). Cineplex Inc (OTCPK:CPXGF) Altman Z-Score. Retrieved April 3, 2015, from gurufocus.com: www.-/term/zscore/CPXGF/Altman%2BZ-Score/Cineplex%2BInc

PricewaterhouseCoopers(PwC). (2015). Independent Auditor’s Report. Toronto: Cineplex Inc.

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