To The Moon

AMC Entertainment was a popular meme stock that reached as high as $393 (reverse split adjusted) on an intraday basis in June 2021, which helped the cinema chain avoid bankruptcy. Today it trades for a miserable $11, after accounting for it's reverse 1-for-10 stock split, taking its share count from 520 million to 52 million, and correspondingly lifting its per share price by tenfold.

This could have been avoidable if the fundamentals of AMC was looked into

Using Gurufocus to look at AMC's revenue, net income, operating cash flow & cash to debt ratios, we find some alarming red flags that should have been a warning for investors. The company's revenue has been on a decline since 2020, when covid struck, and has not recovered to pre covid levels at all. Likewise net income and EBITDA (which is Earnings Before Interest, Taxes, Depreciation & Amortisation). Operating cashflow & free cashflow has been negative for three consecutive years. It's debt levels have been way elevated. 

One should investigate why it's revenues have not recovered. Perhaps there is a shift in consumer patterns, as they are not really going to the movie theatre today. Consumers are more likely using streaming services like Netflix, Disney+, etc. Also in an environment where inflation remains elevated, it is more likely that consumers are trying to save more money, by coming up with ways like password sharing on streaming services, which prompted Netflix to come out with ways to block password sharing.

Next red flag would be Debt-to-EBITDA ratio, which is an alarming 180.72, which implies AMC would need 180 years of earnings to pay off its debt. Also, it's debt-to-equity ratio is negative, implying the company has more liabilities than assets, and a negative debt-to-equity is generally an indicator of bankruptcy! Not surprising as it's cash-to-debt is 0.05!

ROIC (return on invested captial) is negative 2.2, operating margins & net margins are negative!

All these red flags would imply it is a not investable company, because the Warren Buffett's first rule in investing is not to lose money. And the second rule is not to forget the first rule! 

Hence if you did all your due diligence, you would have realised that AMC was always in danger of not doing well, and that speculators were just hyping up the stock to trade retail investors.

Should you have shorted AMC? Technically if you think that AMC would fail, you could short it but be subjected to interest rates on borrowing of stock to short. As AMC has quite a high short interest, at times it will be difficult to borrow shares and the interest rates could reach as high as 100% per year to short the stock! Another way to short it with limited losses is to buy put options, but buyers of options that are out of the money tend to lose money too. In options, the trader is limited by strike price and time, and time decay works against the option buyer.

Let's evaluate a good business like Netflix

Let's evaluate the fundamentals of Netflix, which initially started by shipping DVDs and eventually disrupted Blockbuster's business. Today, Netflix is disrupting the cinema business, as major theatrical releases arrive on Netflix not too long after. 

Netflix's revenues have been rising consistently, and EBITDA has been rising too. Net income for the last financial year has slightly flattened. Also, operating cash flow was negative until 2019, before turning positive in 2020, although slightly inconsistently, which is a bit of a concern. Debt levels are still higher than cash levels, but it's starting to come down.

Debt-to-EBITDA is 0.83, implying it would take less than a year of earnings to pay off its debts completely. Debt-to-equity is 0.74, which is less than 1, and the lower the better. Operating margin & net margin are positive too, so it's a sign that they are profitable. Return of Equity (ROE) is 20.21%, while Return on Invested Captial is 11.09%, which is slightly below the 12-15% ideal range of a good investable company.

Hence the fundamentals of Netflix do pass on a few fronts, but there are some risks involved. One of the risks is that Netflix relies on Amazon Web Services (AWS) to provide speed and consistently deliver best-in-class entertainment to its users. If AWS were to raise prices, it could affect Netflix's profitability significantly, and due to the stickiness of AWS, it would be very costly for Netflix to migrate its content library to another cloud service provider, and could potentially take years to move its content library. As such Netflix has not much choice but to accept the rise in prices of AWS should Amazon choose to do so!

Morningstar has a fair value of $330 for Netflix, and assigned a narrow moat

Since the fundamentals have passed, should you buy Netflix today? Sadly not yet as Netflix today is overvalued. When making an investment, one will always want to buy when it's undervalued. But how do you arrive at valuation? One way would be to use a discounted cash flow model, and work out its fair value. A second way would be to pay for a service like Morningstar, which is highly rated for its valuation services, but Morningstar costs US$249/year. 

Last year it was a buy when it was undervalued. Should you sell? That depends on how much overvaluation one could accept. I would say at most Netflix is a hold if you bought last year at a cheap discount, and hence have a huge margin of safety.

@CaptainTiger 

@TigerStars 

$AMC Entertainment(AMC)$ 

$Netflix(NFLX)$ 

$Amazon.com(AMZN)$