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Let's not go to the movies
Investing pros are betting on theater chains despite the box office slump. Should you?
October 26, 2005: 12:41 PM EDT
By Paul R. La Monica, CNN/Money senior writer
Not a hit but not a flop: Shares of movie theater chain Regal Entertainment have held up reasonably well during this year's box office slump.
Not a hit but not a flop: Shares of movie theater chain Regal Entertainment have held up reasonably well during this year's box office slump.
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Why aren't you going to the movies as much this year?
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NEW YORK (CNN/Money) - It's no secret that this has not been the best of years for Hollywood.

Movie attendance is down and the reason for this is a subject of intense debate. Is it a backlash against rising ticket prices? Are the movies just not very good? Would people rather sit at home and watch DVDs?

It's probably a combination of all these, and other, factors. But one thing is certain. The box office slump is bad news for owners of movie theater chains.

Regal Entertainment Group, the nation's largest theater owner with more than 6,600 screens in nearly 580 multiplexes, is expected to report a sales increase of just 1.6 percent and a decline of more than 25 percent in earnings per share when it releases third-quarter results Thursday.

And analysts are forecasting a nearly 75 percent drop in third-quarter profit for Carmike Cinemas, the third largest movie exhibition company in the U.S.

So why are shares of Regal Entertainment (Research) up about 7 percent during the past 12 months? And why have several hedge funds been buying stakes in Carmike (Research) lately?

Better box office in 2006?

Investors may be betting that the worst is over for the industry.

"The bad news is pretty much already in the stocks," said Dennis McAlpine, an independent media and entertainment analyst. "And the nice thing about the box office is that hope springs eternal. There are good movies lined up for Christmas and big tent poles for next year."

Some believe the box office can see a bounce in the next two months thanks to high-profile releases such as the computer-generated animated film "Chicken Little" and the "Chronicles of Narnia: The Lion, the Witch and the Wardrobe" from Walt Disney (Research), "Harry Potter and the Goblet of Fire" from Warner Bros. and "King Kong" from Universal. (Warner Bros. is owned by Time Warner (Research), which also owns CNN/Money.)

And there are hopes that next year will be a better year for Hollywood than 2005 since several sequels, including "Mission Impossible 3", "X-Men 3" and "Pirates of the Caribbean: Dead Man's Chest" are due out in the summer.

In addition, the latest Pixar (Research) film "Cars" will be released, as will the big screen version of the blockbuster best-seller "The Da Vinci Code."

"There is optimism about next year's slate and some of the industry's problem has unquestionably been weak product," said Matthew Harrigan, an analyst with Janco Partners.

Income-oriented investors may also be intrigued by the big dividends that the two companies offer. Regal pays a dividend that yields 6.4 percent while Carmike's dividend yields 3 percent.

But should investors be rushing into the stocks of these movie theater chains? Analysts say buying Regal and Carmike now might be the investing equivalent of yelling "Fire!" in a crowded theater. In other words, a big no-no.

Stocks still risky

Sure, the dividend yields are pretty rich now. But Harrigan said investors might not want to buy these stocks on the hopes of increasing dividends.

Harrigan questions whether or not Regal's dividend, for example, is safe because the movie business is so cyclical. If the industry does have another off-year, it might be tough for Regal to keep paying such a high yield.

And despite some increased optimism about a box office bump in 2006, this is not reflected in the sales and earnings estimates for Regal and Carmike.

Analysts expect Regal's sales to increase just 4 percent in 2006. And even though earnings are expected to rebound by nearly 40 percent, next year's profits are only expected to be 8.5 percent higher than in 2004.

Carmike's sales are expected to be up 5.6 percent next year and analysts are predicting that profits will triple. Still, earnings in 2006 are expected to be 25 percent lower than earnings from 2004.

Harrigan said that, even if there are better movies in 2006, it still might not be enough to bring people back to the theaters in droves.

"There are real challenges with the economy and rising ticket prices," he said, adding that theater companies need to wow people with new technology to get them more interested in going to the multiplex.

To that end, Regal recently announced that it is partnering with privately held technology company REAL D to present "Chicken Little" in a digital 3-D format on 17 of its screens.

McAlpine said some investors may be excited about the growth prospects for Regal's digital business. But it's probably premature to say whether digital 3-D movies can be the savior of the industry.

And McAlpine added that he even though he does expect ticket sales to recover next year, the popularity of DVD rental services like Netflix (Research) has him worried enough about the future of movie theaters to rate shares of both Regal and Carmike a "hold" for now.

"I'd prefer to wait and see on what consumers are going to do. Maybe the move to watching DVDs on home theaters is going to have more of an impact on the industry. We can't tell for sure until next year," he said.

For a look at media and entertainment stocks, click here.

Do you like scary movies? Click here.

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking ties to the companies.

The reporter of this story owns shares of Time Warner through his company's 401(k) plan.  Top of page

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