The Six Flags inventory (NYSE: SIX) has plunged 48% this year on some headwinds, inflation surging to a 40-year high and fears that the Fed’s aggressive interest rate hikes could trigger a recession. As Six Flags is particularly vulnerable to recessions, it will come under pressure in the event of a recession. However, the stock has become so cheap that it can offer a 50% return whenever the economy recovers from its recent downturn.
The reasons for the plunge
Six Flags was badly hit by the coronavirus crisis in 2020 as it was forced to close its parks for an extended period. It also had to reduce the capacity of its parks due to social distancing measures. As a result, the company burned cash at a record pace and suffered a loss per share of -$4.99 that year. As this loss represents 22% of the stock’s current market capitalization, it is certainly excessive.
Fortunately, thanks to the massive deployment of vaccines, the pandemic began to abate last year and as a result Six Flags recorded a significant earnings per share of $1.50. The pandemic has eased further this year and as a result, the company was expected to increase its profits to pre-pandemic levels this year. However, its latest earnings report was disappointing. Its revenue fell 5% from the year-ago quarter due to a 22% drop in attendance. Average ticket per capita and average customer spend increased by 27% and 23%, respectively, but were not enough to prevent a sharp drop in bottom line. Earnings per share fell 35% from $0.81 to $0.53, missing analysts’ estimates by $0.48. As a result, the stock plunged 18% after its earnings release.
The reason for this disheartening performance was the fact that management eventually decided to eliminate coupons and offers in an effort to reset the shopping landscape. As management stated, customers had become accustomed to deep discounts and that had to change at some point. Unfortunately for Six Flags, its product is non-essential and therefore the demand for its product is heavily affected by the prevailing price. Indeed, while the average ticket price increased by 27%, attendance fell by 22%.
The other major reason for the title’s collapse this year is the war in Ukraine. Some investors may think the invasion of Russia is irrelevant to Six Flags, but it is not. The ongoing war in Ukraine has pushed inflation to its highest level in 40 years. This development made consumers much more conservative and therefore weighed on consumer spending. As Six Flags relies on consumer discretionary income, it is clear that demand for the company’s parks cannot remain immune to high inflation.
High inflation also has another effect on Six Flags. This significantly reduces the present value of the company’s future cash flows and therefore puts a lot of pressure on the stock valuation. It’s also important to note that Six Flags has eliminated its dividend since the start of the pandemic and has no plans to initiate a dividend anytime soon, primarily due to its high debt load. Therefore, high inflation is a significant headwind for the valuation of this stock. This helps explain why Six Flags is currently trading at a price-earnings ratio of just 13.0, the lowest valuation level in nearly 10 years.
Luckily for Six Flags, the aforementioned headwinds appear to be temporary. The company is doing its best to improve the experience of its customers and as a result has achieved customer satisfaction rates well above those of 2021. In addition, customer spending per capita has increased by more than 50% compared to pre-pandemic levels. Additionally, eliminating deep discounts is healthy from a long-term perspective, as it provides a healthy profit base from which the business can grow.
With reference to inflation, the Fed is doing its best to bring the price index back towards its long-term target of 2%. Thanks to its aggressive interest rate hikes, the central bank should achieve its target and inflation should therefore start to decline next year. Such a development will be great for Six Flags for two reasons. This will have a positive effect on consumer spending while providing a tailwind for the stock’s valuation.
With business recovering from the pandemic, Six Flags is expected to increase earnings per share by 17% this year and another 33% next year. If the company meets analysts’ estimates, it will earn $2.34 per share in 2023, 11% higher than the pre-pandemic level of $2.11.
Six Flags is currently trading at 13.0 times its expected earnings this year. Even better, the stock is trading at just 9.7 times its expected earnings in 2023. This has been a low price-to-earnings ratio for nearly 10 years for the stock.
Six Flags has traded at an average price-to-earnings ratio of 29.4 over the past decade. While it is prudent not to count on such a high price/earnings ratio, it is reasonable to expect the stock to return to a price/earnings ratio of at least 15.0 whenever the inflation goes down. If inflation declines significantly over the next three years, which is the most likely scenario, Six Flags should amply reward its shareholders. A realistic price target for 2025 is $34 (= 15 * $2.34), implying 50% upside potential over the next three years.
Although Six Flags looks deeply undervalued at its current price, it also comes with some risk. First of all, the company is very vulnerable to the pandemic. If the coronavirus mutates significantly and evades vaccines, it may lead some consumers to stay away from company parks. Fortunately, such a negative scenario is unlikely thanks to the effectiveness of vaccines and the sustained efforts of pharmaceutical companies to adjust their vaccines to new mutations in the virus.
Another risk factor is Six Flags’ weak balance sheet. Cyclical companies must have a healthy balance sheet in order to be able to withstand declines in their activity. Unfortunately, Six Flags has yet to learn that lesson. During the Great Recession, the company went bankrupt due to excessive debt. Worse still, it has not learned the lessons of this recession and therefore now has a fragile balance sheet.
Its interest expense consumes 35% of its operating income, and its current liabilities ($640 million), which are due within the next 12 months, exceed its current assets ($263 million). Additionally, its net debt (according to Buffett, net debt = total liabilities – cash – receivables) is $3.1 billion. This amount represents 170% of the stock’s current market capitalization and 23 times the company’s earnings over the past 12 months and is therefore excessive. Fortunately, the company is currently generating enough free cash flow to meet its obligations, but it may come under pressure if a severe recession hits.
Finally, there is another risk factor. As mentioned above, inflation should start to subside next year thanks to the Fed’s aggressive stance. Nevertheless, in the unlikely scenario of persistent inflation, the valuation of Six Flags stock should remain under pressure, especially since the stock does not offer a dividend to mitigate the impact of inflation on the market. capital of its shareholders.
Due to the headwinds mentioned above, Six Flags stock is currently trading near its 10-year lows. It was only at the start of the coronavirus crisis that stocks traded below their current price. As the above headwinds are likely to subside over the next three years, the stock may offer a 50% return over this period.
On the other hand, investors should always remember that Six Flags is not a buy-and-hold forever stock due to its high cyclicality. As soon as the stock reaches its target price of $35, investors should consider taking profits.