PVR-Motilal Oswal: Some respite from pandemic woes, but OTT overhang persists

After remaining severely impacted for nearly a year, weighed by the COVID-19 disruption, the Cinema industry’s plea has finally been heard by the central government – cinema operators are now allowed to operate their screens with 100% occupancy.

Although it would take some months for operations to commence entirely (as many states are still restricting occupancy to 50%), the silver lining is that the release of some fresh content in the regional markets has shown good traction.

Moreover, the content pipeline looks strong, with many big banner movies (initially scheduled for release in CY20) awaiting release, including the recent announcement of the Salman Khan starrer ‘Radhe’ in May’21.

The rollout of COVID vaccines and cinemas being allowed to run at 100% capacity in Tamil Nadu are welcome positives. However, pan-India recovery could take longer, until which the risk of lower occupancy may continue to put pressure on cash flows and more blockbusters may be released on OTT platforms.

Fresh screen adds could slow over next 1–2 years
Multiplexes, particularly PVR, have experienced one of the fastest growth rates, driven by consistent screen additions in the last five years; they have benefited from: a) low penetration of good-quality screens in India and b) value migration from single-screen theatres to multiplexes.

The management has indicated that operations at 15–20 new screens, which are in the advanced stage of development, may commence by Mar’21. It further indicated long-term screen adds would remain intact as normalcy returns. Compared with ~80 screen adds each in the last two years, COVID-19 has severely impacted the pace of new screen additions.

We believe this impact may continue to be seen over the next 1–2 years due to the development of new malls – which could prove challenging given the ongoing pressure on real estate players and incremental balance sheet stress due to prolonged recovery. On the flip side, lower rentals in the backdrop of weak market conditions could offer better business economics and aid in accelerating additions.

Changing dynamics in Entertainment market
The improving ecosystem of OTT consumption, led by increased digital content and data penetration, is a well-known evil. This is despite the Cinema segment’s value propositions, such as a better movie-watching experience, limited alternatives for recreation in India, and favorable comparisons with the developed markets (such as the US).

However, occupancy rates are at risk of softening over time due to certain inevitable factors. A) The contribution of movie theatres in the movie revenue pie has declined to 75% in India and ~40% globally.

Over time this could diminish the bargaining power of cinemas in India for exclusive screening windows – this trend is already seen globally. B) Increasing viewership and the growing size of the OTT market are attracting a strong talent pool and the ability to develop good-quality content, which is creating a strong substitute (unlike TV content), especially in a price-sensitive market such as India. C) Deep-pocketed players such as Netflix, Amazon, and Disney, despite weak business economics presently, could invest for the long haul.

Reducing occupancies could pressure earnings, ROCE
PVR’s recent sharp cost-cutting is commendable and underscores the management’s ability to maneuver costs and achieve breakeven at merely 18–20% occupancy levels. Over the last five years, occupancies have improved given multiplexes’ better value proposition. However, any substitution-led softening of occupancy could hurt business economics, the return profile, and earnings growth.

As the business of multiplexes is inherently a fixed-cost business – nearly 60% of the cost is fixed – it is highly sensitive to occupancy and heavily dependent on content pull and the potential threat from OTT.

Thus, a 500bp reduction in occupancy and ticket prices lowers FY23E EBITDA by 54% and ROE by ~13 percentage points. At the stable-state level, the business has the potential to garner 18–20% post-tax ROCE (including corporate expenses). However, with a ~20% portfolio of new screens and components / goodwill, company-level ROIC stands at 12%.

Maintain Neutral
PVR multiple round of fund raise in the recent past has ensured comfortable liquidity but it has led to 15% cumulative dilution. Thus despite the stock being 25% down from its peak, decline in EV has been merely 4% with EV/EBITDA and P/E being merely 5-10% discount to its five year average at 12x and 41x on FY23E.

Our current Base case assumption factors in gradual recovery in FY22, while building in revenue/EBITDA at FY20 levels and 23%/34% revenue/EBITDA growth for FY23E. Over the next 6-9 months, the resumption of total operations should aid earnings recovery, keeping the stock in good stead; however, the overhang of OTT and subsequent risk of softening occupancies could put pressure on the valuation band over time – given the risk of softening occupancies. Thus, we maintain Neutral, with TP of INR1,620 and a valuation of EV/EBITDA of 14x (in-line with the five-year average) on FY23E. mediabrief