Can You Get Value from Penny Stock with a Share Price of Under 4p?

The Cineworld (LSE: CINE) share price has plummeted in recent years to less than 4p. That’s a startling 88% drop from where it stood even at the beginning of 2022 and a catastrophic fall of 99% from its pre-pandemic price.

Does this massive drop make this penny stock a cheap buy or are we looking at a dangerous value trap? I think the answer starts with decisions made even before the pandemic threw a spanner in the works for the cinema sector.

Cineworld amassed an eye-watering debt

Cineworld management spent the years leading up to the pandemic amassing debt in questionable acquisitions.

Before Covid-19, Cineworld made a number of questionable acquisitions. One example that becomes important later was the botched $2.1bn takeover of Canadian rival Cineplex in December 2019.

One analyst criticised the management’s attempts to “build an empire in a sunset industry”. Whether you believe the cinema sector is a dying industry or not, the company built up debt like it was going out of style.

So when the coronavirus kept the world in their homes and away from movie theatres, Cineworld and its competitors like Vue and AMC struggled desperately, having little else to sell apart from overpriced popcorn.

And the knockout punch? As pandemic restrictions were lifted, ticket sales and revenue did not return to previous levels.

The slower-than-expected recovery caused Cineworld to apply for bankruptcy in the US and sent the share price into a tailspin. The market cap now stands at a sorry £58m.

Some good news?

Those revenues are extremely high compared to that market cap, and I see two potential ways out for the firm and its beleaguered shareholders.

The cinema operator has two ways out:

The first potential lifeline for Cineworld would be a takeover. The bankruptcy proceedings issued a final date of 16 February for suitors to establish their interest, so news should be released soon. Rumours have circulated that both Vue and AMC are interested.

The danger here is that any takeover is unlikely to provide a big win for shareholders. In fact, communications from administrators have indicated that investments are likely to be significantly diluted in the event of a restructuring or sale.

Another possibility is simply a long road to recovery. How likely is this? Well, the latest earnings revealed an operating profit of $57.3m in the first six months of 2022. So that’s a step in the right direction, but it’s a fraction of the financing costs for the same period of $409m.

Not only that, but Cineworld doesn’t expect admissions figures to return to previous levels in either full year 2023 or 2024. It might be a long wait before the company can even afford to service its debt.

Oh, and that takeover of Cineplex? The Canadian firm was awarded $1.2bn in damages to be paid by Cineworld after they pulled out of the deal.

So, is it worth investing in Cineworld?

All being said, if cinema goers returned to pre-pandemic levels and Cineworld can weather the storm until then, investors might find value here. A high-risk, high-reward play, and one with just too much risk for me to be interested in buying.

That said, there are some positives. Firstly, the cinema sector is not dead, despite some negative news headlines over the past two years. Cineworld’s recent earnings results showed that it was able to generate an operating profit of $57.3m in the first half of 2022. Although this is a small fraction of its financing costs of $409m, it is a step in the right direction.

The company is also taking measures to cut costs and reduce debt. For example, it has renegotiated some of its rent agreements, and is looking to sell off some of its real estate assets. Furthermore, as pandemic restrictions continue to ease, there is hope that moviegoers will return to cinemas in greater numbers.

This could lead to a boost in ticket sales and revenue, which would help Cineworld get back on track financially. However, the company has warned that it does not expect admissions figures to return to pre-pandemic levels in either 2023 or 2024.

So, while there are some signs of improvement, it remains to be seen whether Cineworld can fully recover from its pre-pandemic debt-fueled growth strategy and adapt to the post-pandemic reality of the cinema industry.

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