PVR: Reaping benefits from herd mentality among its customers

Key details: Price: 790, Mcap: 37.0bn

I have been passively tracking this company for long and believe that it is now in a sweet spot to benefit from multiple structural and cyclical triggers. I would highlight key positives, key risks and explain biz profile briefly. 

Key positives

• Consumerism boom: I see PVR as a key beneficiary of India consumerism boom- favorable demographics (2/3rd of its population is born after 1980s representing millennials and Gen Z who are avid movie-goers), rising affordability/ discretionary income levels, increasing spend on leisure activities, move towards premiumisation, and rapid urbanization are some of the key long-term drivers.
• Structural drivers : This along with structural benefits specific to the cinema sector such as:
• Screen penetration is low in India (9 screen for every 1mn population vs. 125 in USA and 85 in France). 
• rapid shift from single screen to multiplex chains as movie-going is increasingly viewed as an “experience” rather than an “event” (multiplex screens represents only ~16% out of total ~10k screens across India). 
• lack of other meaningful entertainment options for families (theme parks/game zones are few, weekend gateways are costly, and sports entertainment other than cricket is scarce).
• Cultural inclination for movies/ arts and rise of professionally managed production houses (India has highest no. of movie produced every year: ~1600 each year vs. 475 in USA and 750 in China; has second highest cinema footfalls in the world, but is 6th largest movie market in the world with $1.5bn domestic collections)
• Sector consolidation is a big positive: In the last couple of years, due to limited opportunity for organic growth (as new real estate growth has slowed down, license issuance was slow from govt. authorities) industry leaders have grown not only through organic screen additions, but also through acquisition of smaller regional multiplex chains and single screen players - this includes Inox acquiring Satyam, Carnival buying stake in Big/Broadway cinema, Mexico-based Cinepolis acquiring Fun cinemas, and recently PVR buying into DT cinemas. Top 4 players now account for 80% of multilpex screens. Size does matters in this industry as it can help to bargain with distributors over content costs, and lower competition gives scope to increase ticket prices. 

• Leadership position in attractively poised market: Post its acquisition of Cinemax and now DT Cinemas, PVR has strengthened its leadership position (30% and 20% of Hollywood and Bollywood’s box-office share) and has developed a strong brand due to world-class cinema experience resulting in industry-leading ATP and ad-revenue growth. PVR is on track to expand organically (60–70 screens every year) which should further increase its market share and give it a first-mover advantage in small cities leading to strong return ratios.

• Best placed in movie-biz value chain: A report by FICCI-KPMG suggest that film industry has grown steadily at 11% CAGR in the last few years and expected to grow at same pace in the coming years too. Five years back only two movies made it to elite club of 100 cr collections, but that has climbed to 9 movies this year and as difficult to believe it could be every year we have new record being set at box-office. While industry representatives highlights that wider screen releases and improving content quality as a reason for this success, I believe that higher BO collections has increasingly turned into a "marketing" tool, which results into more people flocking to theatres (typical herd mentality) and thereby adding to collections. Within the movie value chain, I think theatre-owners are best-placed as they have lesser risk of movie not doing well as compared to production house/ distributors. 

Key near-term trigger for shares (Why to buy now?): 

• Content over the next few months is promising as big-budget releases are lined up in the next two weeks (Dilwale, Bajirao Mastani and Star Wars) which could see strong box-office collections. Also, movie releases from popular actors are more tilted toward H1 of CY2016 (Raees, Mohenjo Daro, etc) versus a general trend of a quiet H1 period.
• PVR is one of the prime beneficiary of the upcoming GST as currently entertainment tax varies for each state and not available for set-off against service tax it pays on rent, electricity, etc. The headline GST rates are expected to be lower (17-18%) than current tax incidence (25-26%), and will also benefit from input tax credit which should aid its EBITDA margins by 250-3000 bps.
• Food and beverage has high potential: Although spending per head on F&B is improving (39% of ATP), it still lags global peers and gross margins have scope to improve due to in-house preparations.
• Shares have corrected 20% from its recent peak and provide us with good entry opportunity.
• Valuations: PVR trades at FY17E EV/EBITDA of 9x, but is expected to grow its EBITDA by 30% CAGR over FY15-18E. This is at a discount to the Indian consumer discretionary names which are trading at EV/EBITDA 2017E multiples of 15-20x. While return ratios are depressed now (RoE: 4-5%), as it is in investment phase, on a steady state basis PVR should be able to generate 20-22% RoE. 

Key risks 

• PVR’s net debt has increased ~10x in the last four years to finance acquisitions and meet a rapid expansion strategy, which has weakened leverage ratios (net debt/ EBITDA of over 1x): However, I view the situation changing soon, as the recent QIP issuance will be used to fund the DT Cinemas acquisition, and would not expect any major acquisitions in the near term. PVR also announced a non-convertible debt issuance of Rs 5.0 bn to refinance it old debt which should lower interest cost by 80–100 bp.
• Rising movie piracy and change in consumer behavior towards OTT/ online viewing (like in USA) could mean lesser footfalls in theatres: My counter-argument is ticket prices in India are still low as compared to developed world, and the social fad to watch movie on the first weekend has still lot of relevance in India.
• High fixed cost in the biz and if content disappoints, then quarterly revenues/ earnings could  be volatile.  

Biz Profile:

• PVR Ltd is the largest cinema chain India with 475+ screens in over 100 properties in 44 cities across India. It's presence is largely in Western and Northern India (45% / 29% of its total screens), where affordability level is better and regulatory price restrictions are lower.
• Due to its premium location advantage, cutting-edge technology and best-in-class movie experience that it offers, PVR commands highest ticket price and advertising revenue per screen.