-Joey Ray
Call them orcas or call them killer whales – the big mammals helped to sink Seaworld Entertainment Inc. last quarter when their new-found human friends stayed away from the marine theme parks over concerns about the whales' treatment.
And yet there's something else sizable lurking nearby that threatens SeaWorld. Its peers in the amusement-park business are in jeopardy, too.
The creature of which we speak is orca-sized debt, weighing down the balance sheets at SeaWorld, Cedar Fair LP and Six Flags Entertainment Corp. And investors who see the healthy yields at all three concerns need to be aware that the companies are using their cash to reward shareholders, rather than pay down their significant obligations. When a highly leveraged company runs into trouble, like SeaWorld has, management faces more pressure to make its payments.
This story serves to update an article in this space in May of last year, "Theme-park stocks could give even staid investors a thrill." The thrust: Investors had already bid up the shares of the three because they discovered the companies could grow revenues in a lacklustre economy, albeit modestly, while throwing off gushers of cash promptly returned to shareholders in the form of dividends. The shares "may have further to climb," we said, particularly if the North American economy didn't slip back into recession, a common fear at the beginning of last summer.
The advice was, shall we say, mixed. Cedar Fair, owner of 15 parks including Canada's Wonderland outside Toronto, is up nearly 30 per cent since the article. Six Flags, with 18 parks including La Ronde in Montreal, is up 8 per cent. SeaWorld's earnings disaster earlier this month, however, leaves it down 40 per cent. (All returns include dividends with yields ranging from 4.4 to 5.4 per cent.)
To be clear, none of the companies is in any serious danger of default at this time. All have BB or BB-minus ratings from Standard & Poor's, near the upper end of "high-yield" ratings, less politely known as "junk."
The debt numbers, however, are worth considering, particularly when investors are confronted with a sudden, sharp drop in earnings, as SeaWorld admitted last week. All rely on debt for nearly two-thirds or more of their capital. Cedar Fair and Six Flags actually have negative tangible book value. This means when you strip out intangible assets like "goodwill," an accounting entry made to reflect the cost of past mergers, the two don't have enough hard assets – like, say, amusement parks – to cover their liabilities.
Each company has about $1.4-billion to $1.6-billion (U.S.) in debt and generates roughly $400-million in EBITDA, or earnings before interest, taxes, depreciation and amortization. That means each has a debt-to-EBITDA ratio between more than 3 and a little more than 4.
Again, that's not necessarily in the danger zone: A search on S&P's Capital IQ database reveals that about 20 per cent of the companies on the New York Stock Exchange with both $1-billion in sales and positive EBITDA have debt-to-EBITDA ratios over 4.
But earnings misses like SeaWorld's show how quickly a company can go in the wrong direction. SeaWorld had told analysts to expect $450-million to $465-million in EBITDA for 2014. The new guidance implies EBITDA as low as $369-million. The difference means a debt-to-EBITDA ratio that could have been 3.5 at year-end is more likely to be 4.4.
When S&P downgraded SeaWorld's debt to BB-minus on Aug. 14, it also changed its outlook to negative, because of its fears of continued reputational risk from the Blackfish documentary that purported ill treatment of SeaWorld's orcas. S&P said a deterioration of the debt-to-EBITDA ratio to 5 or higher would suggest another downgrade; an upgrade could occur if SeaWorld could get that ratio back below 4.
So, is our new advice to run screaming from these theme-park stocks as if you're plummeting to the bottom of a roller coaster? Not necessarily: When things go right for these companies, the cash flow thesis remains intact.
Cedar Fair increased revenue 6 per cent and EBITDA by 8 per cent in 2013, which led management to boost the dividend by 60 per cent. Six Flags's revenue gain of just under 4 per cent in 2013 led to EBITDA growth of 19 per cent and a dividend boost of nearly 35 per cent.
In recommending Six Flags shares, S&P Capital IQ equity analyst Tuna Amobi sees "potentially sustainable pricing power" at the company's parks and believes the company "appears to be settling into a more consistent dividend and cash flow return phase of its life cycle." (His target price is $44, versus Friday's close of $37.54.)
Jeffrey S. Thomison of Hilliard Lyons says his "buy" rating and $55 target price on Cedar Fair is because its "strong cash flow can allow for meaningful reinvestment in the properties … comfortable debt service, and an attractive cash distribution policy."
And there's even a case for SeaWorld. Citi Research's Jason B. Bazinet, admitting an "extreme mistake" in his previous "buy" rating for the stock, says SeaWorld may beat its new, lowered guidance; move toward turning itself into a tax-saving real estate investment trust; or plunge into a $250-million stock buyback that could take 16 per cent of the company's shares off the market at today's prices.
One or more of these things could happen, he says, before investors decide that the Blackfish documentary has done permanent damage to the company. There's still risk, though, that SeaWorld could see a sustained attendance decline. "As such, investing in SeaWorld's equity, even at current levels, is not for the faint of heart."
It's a risk found in any company that relies on the good graces of the public for its revenue – and passes on its profits rather than aggressively reducing its whale-like debt.
Globe app users click here for a table showing earnings results for SeaWorld, Six Flags and Cedar Fair
David Milstead