Why Cedar Fair (FUN) is a very good business (Part 3 of 3)
The few analysts that cover Cedar Fair (FUN) stock tend to value shares on a multiple of EBITDA. A quick look at FUN’s peer group shows the stock trading well below the industry average. It appears that the market does not yet appreciate the safety of modern rollercoasters or the defensive characteristics of the relatively small and underfollowed amusement park industry. If management is able to achieve its long-term goal of $450 million in EBITDA by 2016, and the market values FUN in line with its closest competitor, SIX, the stock would be trading at twice today’s levels. Broyhill doesn’t think either of these factors are unreasonable assumptions, but uses more conservative estimates to generate a range of fair values for the stock.
Investors may also view an investment in FUN in a similar context as MLPs, utilities, or REITs, where the company’s stable and growing cash flows are valued relative to the yields available in the current marketplace. In this respect, the market’s Pavlovian reaction to “tapering” presented investors with a compelling opportunity to purchase FUN at a price that should generate a double-digit dividend yield on Broyhill’s estimate of normalized earnings power. This is not 1994 or 1975. If the Fed could create inflation, it would. But it can’t. Instead, inflation expectations have collapsed year-to-date, despite the mini-rally in yields, consistent with the pattern in 2010, 2011, and 2012. Investors have seen this movie before, and each time, the surge in yields was followed by an even greater move lower. Don’t expect anything different today, as the multipliers between money and credit remain broken, and as a result, the economy depends upon low rates to keep the system alive.
Prudent investors looking for a little FUN stand to do quite well in this environment, as the market should continue to bid up the price of high-quality income-generating assets. Annualizing the company’s recently increased quarterly dividend, the stock yields 5.8% today, which is quite attractive in a zero interest rate world, yet slightly below the company’s 7% long-term average yield. Historically, the company has traded 200 basis points over Treasuries, although admittedly, this spread has varied greatly over time. Even still, this is a good place to start for perspective. With this in mind, investors can develop a range of fair value estimates based on normalized earnings power three years out. Broyhill assumes top line growth of 2% to 4% given limited supply and competitive dynamics, which should continue to benefit pricing. Growth at the low end results in no margin expansion over this forecast period, while better-than expected sales would drive increased profitability at the top end of the range, resulting in a 100 basis point increase in EBITDA margins. For each scenario, Broyhill assumes the company spends 9% of sales annually on capital expenditures, along with additional expenditures while paying out 90% of distributable cash flow net of fixed charges.
The end result of this exercise is a range of 2016 distribution estimates from $3.50 on the downside to $4.00 at the high end. Investors can capitalize these unit distributions at various rates to derive fair value estimates. The results are quite compelling, with little risk on a three-year horizon even assuming an 8% discount rate—over 200 basis points higher than today and almost 500 bps above Treasuries. Conversely, capitalizing the bull case distribution at the current yield should produce a total return of 60% for investors. And in an extended environment of zero interest rates, an even lower yield is not out of the question—the stock traded at a 4% yield in 2011–2012. Now that is FUN.
The Market Realist Take
A Market Realist article from last month, Why the Fed’s tapering delay should be positive for MLPs, stated that incoming Fed chief Janet Yellen is seen as more supportive of easy money policies and low rates. So having Yellen as the Fed chief supports lower interest rates, which is positive for MLPs. Over the past several weeks, interest rates have broadly moved lower due to reduced fears of Fed tapering and Janet Yellen’s nomination. The movement lower in rates is a medium-term positive for MLPs. Plus, in a long-term context, rates remain at historical lows. This is also a long-term positive for MLPs.
Cedar Fair is structured as a Master Limited Partnership (MLP), so investors receive distributions instead of dividends. It’s one of the MLPs that doesn’t fit into any of the business categories permitted by Congress. It operates as a “grandfathered” publicly traded partnership (PTP), as it came into existence before the 1987 law that limited MLPs to businesses involving natural resources (including oil and natural gas), real estate, and commodities.
The company’s board recently increased its quarterly cash distribution by 12% to $0.70 per limited partner (LP) unit, payable December 16, 2013. It said it remains committed to strategically deploying capital in order to generate the highest returns for its unitholders in both the short and long terms. Cedar Fair peer Six Flags Entertainment Corporation (SIX) also announced that its board of directors approved a 4.4% increase in its quarterly cash dividend from $0.45 to $0.47 per share of common stock. In September, SeaWorld Entertainment (SEAS) declared a cash dividend of $0.20 per share, which was paid on October 1, 2013.
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