Not All Cyclical and Capital Intensive Companies Are Bad Investments
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The biggest gripe that investors have with theme park operators is the cyclicality and capital intensive nature of such businesses. But this does not necessarily represent the complete story, as unique assets are typically the source of structural competitive advantages.Six Flags (NYSE: SIX) is the largest theme park operator globally with 18 parks located in the U.S., Mexico, and Canada. The price tag of $300 million to build a theme park helps keep new entrants at bay.
Is cyclicality an issue?
Six Flags saw its revenue drop 10% year-on-year from $1 billion in fiscal 2008 to $910 million in fiscal 2009 due to a combination of swine flu fears and the Global Financial Crisis. But everything must be viewed in perspective -- a 10% drop is not exactly catastrophic. There are two major reasons why fears over the cyclical nature of theme parks are overblown.
Firstly, there is a substitution effect that comes into play, in the event of an economic slowdown. Just how staycations and cruise vacations have gained popularity with budget constrained consumers in difficult times, theme parks are also increasingly being seen as a key leisure alternative to overseas travel.
Secondly, season pass holders accounted for 44% of Six Flags’ total revenue in fiscal 2012, up from 27% in 2008. Season passes help convert passive annual visitors to customer evangelists who bring friends and relatives along with them for their multiple visits.
Why capital intensity is a competitive advantage?
Investors tend to associate high capital intensity with low profitability metrics. However, I think sustained profitability is more important, which is derived from competitive advantages. Most structural competitive advantages are the result of hard-to-replicate assets and prime locations. This is the case with Six Flags.
Based on Six Flags’ estimates, it takes about $300 million and two years of developments to build a theme park of similar scale to that of its current theme parks. This creates significant barriers to entry for new entrants or existing competitors building new theme parks. In addition, nobody wants to stay near a theme park with people screaming hourly on roller coasters, resulting in a ‘not in my backyard’ mentality. Consequently, zoning restrictions limit the supply of new theme parks into the market.
Six Flags grew quarterly revenue and attendances year-on-year by 32% and 41%, respectively, to $88 million and 1.8 million guests for the first quarter of fiscal 2013. This was achieved on the back of strong admissions and increased upselling of season passes to guests. It continued to reward investors with both dividends and share buybacks.
Six Flags repurchased 6.1 million shares worth $404 million from January 2013 to April 2013, which represented over 11% of outstanding shares at the end of 2012. Its forward dividend yield of 5.1% is supported by a cash EPS yield of 6% and a $1 billion Net Operating Losses (NOLs) carry forward which could potentially shield taxes for five years.
In addition to being an owner and operator of 11 amusement parks, Cedar Fair also has water parks and hotels in its portfolio. Cedar Fair is the closest listed pure play competitor to Six Flags, competing in almost every part of the U.S. However, promotions and attractions are hardly differentiating factors for theme parks operators, and customers typically choose between Cedar Fair and Six Flags based on distance rather than any other factor.
Based on the lower end of management guidance, Cedar Fair is expected to grow its 2013 full year revenue and adjusted EBITDA by 2% and 2.3% to $1.09 billion and $400 million, respectively. I am not considering Cedar Fair, as it is not a pure theme park operator given its significant hotel exposure. Moreover, it is significantly more leveraged than Six Flags. Also, unlike Six Flags and SeaWorld, Cedar Fair does not have NOLs to minimize corporate taxes.
Listed in April 2013, SeaWorld operates 11 theme parks. Although SeaWorld has parks located in San Antonio, where Six Flags also has a presence, it is differentiated from Six Flags. SeaWorld's theme parks are positioned more as destination parks, serving overseas travelers staying overnight near or within the park. As a result, SeaWorld is relatively more economically sensitive than theme parks with more of a domestic customer base like Six Flags.
SeaWorld grew revenue 12% year-on-year in the first quarter of fiscal 2013, driven by better yield management strategies with a 10% increase in revenue per capita over the same period. A REIT conversion could be a positive catalyst for the stock in the future, when its NOLs amounting to more than half a billion at the end of 2012 are fully utilized. SeaWorld’s forward dividend yield of 2.3% is inferior to that of Six Flags, putting it out of contention on my buy list.
Six Flags is not cyclical as perceived by investors, given the increasing contribution of season pass holders to the top line. In addition, I see Six Flags’ asset heavy balance sheet as an advantage, as its theme park assets create formidable barriers to entry for new entrants. However, its recent strong financial performance and competitive advantages seem to have been factored into the share price. At 24 times forward P/E and 12 times EV/EBITDA, Six Flags is overvalued. I will prefer to consider the stock again when it is trading at 8-10 times EV/EBITDA.
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