During the first five months of the year, risk assets marched steadily higher as central bank asset purchases abolished volatility from financial markets. In the wake of a more hawkish Fed, this veneer has begun to crack, with rising turmoil in financial markets catching many investors off guard. Rising bond yields spurred a reversal in bond proxies, and high-dividend-yielding stocks were no exception. The thinking goes that once the Fed removes liquidity from financial markets, the need for dividend yield will evaporate along with demand for high-dividend-yielding stocks. But domestic stock markets have experienced double-digit drawdowns in each of the past three years. If the rise in yields were to stall economic growth and trigger a deeper correction, we think the defensive nature of high-yielding equities would trump interest rate risk. In such an environment, we would expect the Fed to engage in even more QE, and as a result, high-quality dividend payers should remain an attractive alternative for investors.
Last month’s sharp correction in bonds and bond proxies provided investors with an opportunity to briefly lock in higher yields across a number of securities. We pitched one of our favorites to our friends at Value Investor Insight (VII). VII is a subscription-based monthly publication filled with high-quality interviews and investment ideas from the world’s top value investors. It is an excellent resource for idea generation and uncovering value. This month provided investors with a “Cheap Thrill” and summarized our thesis in shares of Cedar Fair (FUN). The article is available here with the permission of Value Investor Media, Inc.
The few analysts that cover the stock tend to value shares on a multiple of EBITDA, as discussed in VII. But we also view an investment in FUN in a similar context as other “bond proxies” where the company’s stable and growing cash flows are valued relative to the yields available in the current marketplace. In this respect, we believe the market’s Pavlovian reaction to “tapering” has presented investors with a compelling opportunity to purchase Cedar Fair at a price that should generate a double-digit dividend yield on our estimate of normalized earnings power. Prudent investors looking for a little FUN stand to do quite well in this environment because the market should continue to bid up the price of high-quality, income-generating assets. Based on an estimated 2013 distribution of $2.50, the stock yields 6% today, which is quite attractive in a zero-interest-rate world, although it is below the company’s 7% long-term average yield.
In our initial write-up on the stock, available here, we offered a range of fair value estimates based on normalized earnings power three years out. “The end result of this exercise was a range of estimates for 2016 Distributable Cash Flow, which range from $2.25 on the downside to $3.50 at the high end. We note that our bear case on the stock assumes a lower level of distribution than the company is paying today, while our bull case is essentially in line with the low end of management’s long term EBITDA guidance. In other words, we are being very conservative in our estimates. Finally, we capitalize our unit distributions at various rates to derive our fair value estimates. The results are quite compelling. Downside risk looks to be in the neighborhood of 10% after adjusting for anticipated distributions and assuming an 8% discount rate — nearly 200 basis points higher than today and almost 600 bps above treasuries. Conversely, in an extended environment of zero interest rates, we don’t think a 4% yield is out of the question — FUN approached these levels in 2011–2012. Capitalizing our $3.50 distribution in this environment would result in returns in excess of 100% plus distributions.”
Comments from Matthew Ouimet at the JPMorgan TMT Conference echo many of the sentiments presented in our report. Here are a few nuggets worth considering so that you don’t miss out on all the FUN:
From Staycations to Funcations
“I think what we are seeing now is Staycations are going to migrate to what we are calling Funcations; during this time period we re-trained America that road trips were fun. It is not easy to go through an airport with a bunch of colleagues. So I think what you are going to see is that actually the ritual visit for the two or three hour drive to Regional Amusement Parks will survive very well as the economy recovers. I don’t think we will lose people because of that and will actually pick up those people who we have lost because of economic situations as the economy improves.”
Economics of Season Pass Holders
“So what seems to be playing out, and I think it’s playing out for the whole industry, is Season Pass Programs across the industry are viewed as great value by the consumer. The Season Pass guys are also the ones who are bringing either their neighbor or their sister along so if it’s 40% of attendance on a direct basis there is some other factor on top of that. Deferred revenue was up 30% in the First Quarter and is not all Season Pass revenue but it is a good indication of where we are this year.”
“The Season Pass holders perform as you might expect. On their first visit they come in, they’re excited, they stay long, they buy food and beverage, they buy merchandise, and they go home and look very much like your average customer. The visits in between — for the most part — their food and beverage spend and their merchandise spend is less than the average visitor.”
“They are the most profitable customer we have on an annual basis. There was a period of time in the industry, when the industry didn’t like Season Pass holders and I think it was more emotional than intellectual because it’s a declining per cap as I just described. But the reality is that you make a lot more money off them; plus, if you factor in the influence factor — the sister-in-law, the brother-in-law they’re bringing — that’s their pattern. And so what’s important about that is our CRM system being able to identify how all of them performed will allow you to get that incremental purchase of some sort in the middle.”
Profit from Pricing
“I continue to be most excited about the value proposition that the consumer recognizes. This was an industry that for the longest time lived off heavy discounting and trained the consumer to expect a certain price for each of our markets. The reality is, it’s not the demographic differences that drive the pricing differences, it’s the legacy pricing — we trained the consumers in each of the markets to expect a certain price. Season Passes, which I said earlier, may represent 50% of our attendance this year. We are up so far this year substantially in units but we are also up substantially in price.”
The Fast Lane
“Fast Lane came from the realization that we have economies that are bifurcated these days and if you have a consumer discretionary product that you track, you can see it very clearly, and so you got these benefit-oriented consumers who . . . aren’t really price sensitive, they buy the front ticket, they take it with the park at the front gate, they walk in and they immediately turn around and pay $50, $60 or $70 more for front of the line pass. And so in the industry, we probably were late to the party on those front line passes. We had very good success for the last year but we didn’t find the pricing ceiling. So we took the pricing up this year as good business people do and we also introduced a second tier product. We sell out of Fast Lane. We do that intentionally because you have to make sure that product is worthy of the price you are charging and that it doesn’t negatively impact the other people. . . . It has been very successful and I think we are going to continue the program.”
Margins & Profitability
“We have the best margins in the industry and have 36%–37% in operating margins. What I like to say is we can grow that margin and/or we can grow margin dollars and I think we have to be careful. I have no doubt we’ll sustain our operating margin, I think that over time we will be able to grow there, but we want to make sure that we are not doing so at the expense of margin dollars. So I think you’ll see our margin percentage grow, I know you’ll see margin dollars grow, but I don’t know that the industry has earned the right to be more than 40%. So, I think you’ll creep up and at some point the consumer checks you on that a little bit, and we will continue to invest in the product.”
“What’s great about this industry is that there are real barriers to entry. You will not see another major regional amusement park business country in our lifetime — it’s too expensive to take too much land and entitlement issues, etc. The only one that was attempted was in Myrtle Beach a few years ago and it closed before the first season was over. So, the way we think about it is a couple of ways. One is, we don’t consider those names competitors when considering comparables. I think from a management standpoint it gives me an opportunity to see some information and now that Sea World is public and Six Flags is doing what they are doing, to be able to encourage ourselves to take advantage of best practices and benchmark. We don’t overlap in almost any markets at all which is a nice thing. I think the other thing from an investor’s standpoint is now that we no longer have to defend why Six Flags went through bankruptcy; we validated the business model across the industry. So the business model is healthy.”
Bottom Line: The industry’s natural competitive dynamics provide FUN with a defensive moat in the form of high barriers to entry, local monopolies, and little risk of new entrants. Combining this attractive competitive backdrop with management’s renewed focus on pricing, driven by the initiatives discussed above, should result in significant top-line growth in the years ahead. To Poor Charlie, this is as good as finding money in the street: “You will get a few opportunities to profit from finding underpricing. There are actually people out there who don’t price everything as high as the market will easily stand. And once you figure that out, it’s like finding money in the street — if you have the courage of your convictions.”