Top Investor Updates for the Movie Rental and Exhibitor Industry

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

This biweekly newsletter lists key events in the movie rental and exhibition industries for the period between October 22 and November 4, including notable rental releases, box office figures and recent company-specific news.

Movie Rental Industry

Key Redbox releases this year (with domestic box office total in millions from www.boxofficemojo.com):

o 10/23: Madea’s Witness Protection ($65).

o 10/30: Magic Mike ($114).

Key Redbox releases last year* (with domestic box office total in millions from www.boxofficemojo.com):

o 10/25: Captain America: The First Avenger ($176), Winnie the Pooh ($27).

o 11/1: Fast Five ($210), Cars 2 ($189).

*estimated release date, **was originally slated for 8/21 but released on 8/28 according to www.redbox.com

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Over the next two weeks, there are two notable rental releases compared to two last year (notable releases are those that grossed over $50 million in domestic box office). We expect DVD rental for the upcoming two week period to outperform the comparable period last year, as The Amazing Spider-Man and Prometheus combined earned $389 million at the box office compared to $234 million earned by Horrible Bosses and Green Lantern last year.

Redbox has made a conscious decision to increase traffic and frequency of rentals and will purchase more inventory than it typically does in the fourth quarter to improve copy depth, placing pressure on profitability, as implied by guidance. In our view, the improved copy depth could appeal to both Redbox’s most loyal customers (by luring them back to kiosks more often for their second and third choices) and its occasional patrons as well (who will have an increased ability to rent their top choice in a given visit). However, revenue growth may take several weeks to return, and profitability will remain challenged throughout the quarter. Profitability and declining comps are on investors’ minds given the large drop in EPS from Q1 to Q4 of 2012, making a return to positive revenue and earnings growth imperative.  Increased copy depth in Q4 will likely create greater demand into Q1, resulting in significant sequential EPS growth as inventory will require less frequent replenishment.

As expected, Netflix (NASDAQ:NFLX) finally lowered its unrealistic domestic streaming subs guidance with its Q3 report. Management lowered full-year net adds guidance to 4.73 – 5.43 million, well below the 7 million guidance it has provided all year. We continue to believe there are not many catalysts for continued domestic streaming growth, as the company has already converted the vast majority of potential streaming subs on mobile devices, consoles, and smart TVs into paying subs. We also view consensus estimates for domestic earnings power as overly skewed in favor of domestic streaming, which we think is only mildly profitable, and we believe that continued declines in DVD subscriptions will dramatically reduce domestic earnings at the same time that international expansion continues, making profitability in 2013 less likely. We do not see an acquisition of NFLX on the horizon.

Exhibitor Industry

Regal (NYSE:RGC) and Carmike (NASDAQ:CKEC) have already reported Q3 box office results roughly in line with the industry, and Cinemark (NYSE:CNK) will report this week. According to boxofficemojo.com, domestic box office results for the quarter ended September 30 were down 6.9%. The few Q3 hits did not offset a number of misses at the domestic box office. July began well, with late-June releases performing above expectations, but July releases mostly disappointed.  The Dark Knight Rises was the standout summer blockbuster, as expected, but was negatively impacted by the Colorado incident. August was plagued by cannibalization from the Olympics and a generally weak box office, while September releases were uncompelling.

We estimate that Latin American box office trended down in Q3 in U.S. dollars, while trending up in local currency. According to boxofficemojo.com and our calculations, and after weighting each market, we estimate that Cinemark’s combined Latin American markets were up 2% in local currency after accounting for the additional theaters Cinemark acquired last year.

Q4 quarter-to-date box office is trending up over 20%. October ended up 10%, led by Taken 2, and November month-to-date is up dramatically due to new releases Wreck-It Ralph and Flight. We expect next week’s release, Skyfall, to perform well, but the Twilight finale will likely lead November, and The Hobbit will likely lead December releases. We recall that in Q4:11 the release slate was crowded with single-genre weekends, and overall box office receipts suffered as a result. We do not view this as a risk to Q4:12 given a variety of blockbusters within all genres as well as more favorable timing of the release slate compared to last year. As a result, we view our Q4 box office estimate of up 6.2% as conservative.

Michael Pachter is an analyst at Wedbush Securities.

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