Institutional Equities Film Exhibition Sector 4 July 2019 World-Cup And Weak Content To Result In Subdued Quarter Girish Pai Head of Research 1Q is typically a strong quarter for the multiplex industry. However, the on-going 2019 Cricket World Cup [email protected] and relatively weak content vis-à-vis 1QFY19 have acted as dampeners on footfalls and advertising +91-22-6273 8017 revenue growth, leading to what we estimate a subdued performance. This was factored in by the market with Inox Leisure and PVR delivering only 0.6%/1.46% QoQ stock return in 1QFY20. Given that both 1QFY19 and 4QFY19 were very strong quarters, the QoQ and YoY growth and margins will look weak in 1QFY20. The reported 1QFY20 numbers will be under INDAS116, which will result in expanding EBITDA margins while putting mild pressure on PBT. On a reported basis, PVR will benefit from the acquisition of SPI Cinemas as it was not in the base quarter (1QFY19). It was acquired in mid 2QFY19. EBITDA margins (ex-AS116) will come off both on a QoQ and a YoY basis due to modest footfall growth, muted advertising revenue growth and costs connected with the aggressive opening of new screens over the last 12 months. Inox and PVR opened 21 and 27 screens respectively in 1QFY20. While footfalls were adversely impacted because of the World Cup, large corporate customers spent their advertising budgets elsewhere during the quarter because of it. Though the quarter looks subdued, we are positive on the sector. The sector is riding on industry tailwinds such as: (1) Lower Goods and Services Tax (GST) rates leading to higher ticket volumes, (2) Waning F&B controversy. (3) Improving nature of content – wherein instead of depending on a few large-budget-star-based movies multiple small budget movies with stronger scripts are being well received by viewers. This lowers content risks and (4) Strong mall openings as the retail sentiment picks up after ebbing of the online onslaught. These industry tailwinds have empowered multiplex players to go for expansion and invest in new technologies e.g. 4DX, IMAX, ScreenX, etc. 2QFY20 looks promising based on the content pipeline (Movies like Super30, Spider Man, Top Gun, Lion King, Mental Hai Kya, Hobbs and Shaw: from Fast and Furious Franchise, Mission Mangal, Batla House, Saaho etc are set to release). We have assigned a target EV/EBITDA multiple of 12.5x for PVR and 10x for Inox Leisure on their respective FY21E EBITDA. The premium commanded by PVR is because of its dominant position in the industry, its market-leading operating metrics in ticket pricing, F&B pricing and also on advertising revenue per screen. While we like both stocks, we have held the view that the large valuation gap between Inox Leisure and PVR will narrow as Inox Leisure tries to address the problems connected with its advertisement and F&B revenue weakness. Relatively weak content in 1QFY20: On a relative basis YoY and QoQ, content in the quarter was weak with movies like ‘Student of the year-2’, ‘Alladin’, ’Godzilla-2’ and ‘X-Men: Dark Phoenix’, ‘Dede Pyar De’, all of which failed to garner much response from the audience. ’Kalank’, which was expected to be a blockbuster also tanked after a good opening. ‘Avengers: Endgame’, ‘Bharat’ and ‘Kabir Singh’ turned out to be hits, relatively. 1QFY19 was a rather strong quarter due to movies like: ‘Avengers: Infinity War’, ‘Raazi’, ‘Race3’, ‘Baaghi 2’, and ‘Jurassic World: Fallen Kingdom’. Hence, 1QFY20 will likely suffer from a higher base effect. 4QFY19 was one of the strongest quarters ever witnessed in industry’s history in terms of content. 4QFY19 had content successes like: ‘Simmba’ (continuing from 3QFY19), ‘Uri’, ‘Manikarnika’, ‘Luka Chuppi’, ‘Badla’ and ‘Gully Boy’. ‘Uri’ emerged as one of the 10 highest grossing Hindi movies of all times. Some of these movies ran for many weeks leading to generation of better margins for the multiplex players. Margins will be hit because of lower growth in footfalls, tepid advertising revenue growth and initial costs for new screens: The aggressive addition of new screens in our view will lead to higher costs which may not be defrayed as the screens would be running sub optimally from an occupancy perspective. This would have been compounded by the Cricket World Cup June 2019 Quarter Result Preview Quarter Preview June 2019 Result effect. In addition, we believe annual increments given to employees and weaker growth in the higher margin advertising revenues will lead to EBTIDA margin (ex AS116) pressure by 150-200bps across the companies. Ind As 116 implementation could increase reported EBTIDA margin but lower PBT in initial years of the lease: Beginning 1 April 2019, the multiplex industry has moved towards implementing IndAs116 on lease accounting which will change the way the P&L and Balance Sheet is reported (without changing the underlying cash flows). Rent expenses, which have been at 17%- 18% of sales for PVR and 14%-15% for Inox, will get added to the EBITDA margin. However, depreciation and interest costs will rise more than commensurately, leading to a small hit at the PBT level. We understand that this change will be reported prospectively and a reconciliation provided to compare with 1QFY19. This change will also bloat the balance sheet of companies, leading to lower return ratios. While the rental payments will be the same as were agreed upon earlier between the multiplex operators and the mall operators, the accounting for it could lead to upfront pain with relief towards the backend of the lease. 1QFY20E 1QFY20E EBITDA margin (%) 1QFY20E CMP TP Upside Company Revenues YoY growth EBITDA YoY growth PAT YoY growth (Rs) (Rs) (%) 1QFY20E 1QFY19 (Rsmn) (%) (Rsmn) (%) (Rsmn) (%) PVR 1,692 2,017 19 8,860 27.3 1,608 17.2 18.2 19.7 487 (6.9) Inox Leisure 323 413 29 4,706 13.4 843 1.0 17.9 20.1 318 (13.8) * Reported Numbers could be different as INDAS116 will be implemented in 1QFY20. ** PVR numbers for 1QFY209E are consolidated and include those of SPI Cinemas. SPI was not in the base quarter. Source: Companies, Nirmal Bang Institutional Equities Research Institutional Equities We are positive on the film exhibition sector (see our sector report: Indian Film Exhibition Sector- Oligopolistic Business In Its Infancy). We believe that: (1) Indian multiplex industry is an oligopoly (top four players control ~70% of screens) and will remain so as entry barriers are quite formidable and there are no substitutes. This industry’s structure will deliver steady revenue growth, and improve margins as well as RoIC over a long period of time. (2) PVR and Inox Leisure (the two large players) can deliver in the next 10 years at least 5%-10% volume/footfall growth (new screen-driven, attracting both single-screen and new generation customers) per year, respectively, with the rise in realisation of 4%-5%. This will result in revenue CAGR of 10%-15% with PAT growing a tad faster. Structurally, expectations of a rise in relevant customer households which can afford this type of entertainment (currently at 8%-11% of total, in our view) is going to drive demand. Same store/screen sales growth (SSG), in our view, will be realisation-led at 4%-6%. We believe that: (1) These players deserve premium valuations, considering the longevity of earnings compounding and good RoICs. (2) Expensive M&A activity in the past five years and consequent weak return ratios are a small price to pay for achieving consolidation in a nascent industry. Over the long run, as organic growth predominates, the benefits of a better industry structure will far outweigh the price paid. We believe the stranglehold over retail real estate (and slow pace of its expansion) will be the key driver of positive industry dynamics. This will lead to a steady increase in capacity, solid pricing power and a high occupancy rate. The key risk to sector earnings tends to be the volatility induced by success of content. This is a very difficult thing to predict. Some movies may look great on paper, but may turn out to be duds at the box office. But increasingly the content risk is being lowered as Hollywood and regional movies (both in their original and dubbed versions) are able to command a greater share of GBOC. Also, of late the content has been less star-driven and more based on good story lines which may be a structural shift happening in the industry for the better. 2 Film Exhibition Sector Institutional Equities DISCLOSURES This Report is published by Nirmal Bang Equities Private Limited (hereinafter referred to as “NBEPL”) for private circulation. NBEPL is a registered Research Analyst under SEBI (Research Analyst) Regulations, 2014 having Registration no. INH000001436. NBEPL is also a registered Stock Broker with National Stock Exchange of India Limited and BSE Limited in cash and derivatives segments. NBEPL has other business divisions with independent research teams separated by Chinese walls, and therefore may, at times, have different or contrary views on stocks and markets. NBEPL or its associates have not been debarred / suspended by SEBI or any other regulatory authority for accessing / dealing in securities Market. NBEPL, its associates or analyst or his relatives do not hold any financial interest in the subject company. NBEPL or its associates or Analyst do not have any conflict or material conflict of interest at the time of publication of the research report with the subject company. NBEPL or its associates or Analyst or his relatives do not hold beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of this research report.