Earnings Analysis: Cedar Fair (FUN)

Back on Tuesday, Cedar Fair announced the results of their third quarter operations.  Results were pleasantly pleasing as revenues came in at $664M, which is about 1% better YoY.  Earnings came in at $3.76 which was well in excess of analyst expectations of $3.25.  Results were bolstered by an increase of both attendance and spend coupled with cost management within the organization.  July was seen as a volatile month for the company, weather-wise, resulting in lower than expected visitation during a key portion of the year.  However, in the following two months of the quarter, attendance and spending rebounded and exceeded expectations as season pass holders returned to the facilities with better overall weather patterns.  This trend continues into October with the various Fall festivals which they hold and 2019 season pass purchases are off to a strong start - to show ongoing strength for the next year.  As a result of these patterns and how it fits into management's view of the world and the progression of their strategy, the board has approved a 4% distribution increase effective this quarter.  

To do their best to compensate for the impact weather has on the business, management continues to employ a strategy that leverages the use of hotels and amateur sports facilities to draw a continuous flow of revenue.  This work requires ongoing investment over the coming years to see the results as it takes time to build facilities.  From a long-term investment strategy, I think this is wise.  However, I don't see it benefiting the stock over the next 12 months.  Analysts are clearly worried about three things.  First is whether or not the company will have to reduce their payout, which is now just over 7% after the increase announced.  The second is weather pattern related, as they want to know if weather will continue to have these large negative impacts despite management saying that it typically evens out over the course of the year.  Finally, they are also worried about costs - particularly in terms of wage inflation.  As the economy has been heating up and the current job rates are at the sub 4% levels that they are, it is expected that wages are going to grow to get the necessary talent.  The company will be challenged to keep rising costs under control as well as proving they have pricing power. 

This all brings me to my position on the stock.  The quarter's results were, indeed, good.  I can imagine how much better it would've been were weather patterns more favorable in one of their busiest months of the year - you're probably looking at $4 earnings for the quarter.  As such, it's possible that the company is currently under valued and there is great upside in front of this.  However, there are a couple things that aren't sitting well with me either.  The first is the short-term view I just spoke of.  I see it taking time to see the benefit of the accommodations efforts and because of that, this may not be the time to be in the stock unless you're willing to tread water.  The second thing that bothers me is how promotional the company has become.  CEO Richard Zimmerman said the following in his conference call remarks (bold call outs are my own):
Our third quarter results reflect a successful execution of a number of aggressive targeted promotional activities that not only drove volume but protected the integrity of our mission pricing structure and drove increases in in-park spending.
These initiatives include the continued expansion of multi-week special events such as Cedar Point Nights on the park's our mile-long beach, Christian Music Concerts, and DOLLAR DAYS promotion where value-oriented guests can buy hotdogs, pizza, and other food items for a dollar. During the quarter, we also activated incremental distribution channels such as Groupon and introduced new promotional product such as a park and play ticket and a discounted senior ticket.
I understand promotional activities are a necessity to drawing customers to your parks and accommodations.  What bothers me is that these promotions appear to be leaning towards price discounting and targeting customers who are not likely to continue to come to the parks when those discounts undoubtedly end.  One thing I've learned from having Pepsico in my portfolio is that discount promotions are a double-edged sword.  They may increase volumes, but if the customer isn't willing to pay more later it's going to hurt you at some point.  The third thing that bothers me some is historical trends.  The stock, historically, doesn't perform as well in times of high economic growth.  People who feel better financially are more likely to take a big trip or go on other kinds of adventures instead of going to their local theme park.  Attendance on the quarter refutes my thought process, however, on the year it is still in line, with attendance numbers still down on the year compared to a year ago.  We won't know for sure until the end of the year.  Finally, I'm also concerned about the company's messaging and how it has changed.  In the past it was about EBITDA growth and reaching the $500M EBITDA target.  Yes, it's true that they have missed this target and I'm just as disappointed as they are.  However, I get concerned when a company starts promoting how great/high it's (dividend or distribution) payout is.  This tends to be a red flag more often than not for most companies.  So to hear management state numerous times how much value there is as shown by the 7% yield, my hairs start to go up.  I want to know more about how the company is growing than how valuable they are.

As such, I currently maintain this stock with a rating of a three.  While I believe the strength in the quarter can be a positive and maybe the negatives are already priced in, I'm finding myself in a difficult position to believe otherwise yet.  Admittedly, I can easily second-guess myself right now.  However, I just don't see the growth the company needs to warrant a multiple of 20.  Given growth and interest rate impact, I expect 18 is more acceptable.  I do believe if growth can't be found, it will mean the yield and payouts are also at risk.  Should the economy start to falter or growth be found, my position would change.  Taking analyst expectations of earnings for 2019 to be at $3.23 (they often seem to be high with their expectations), I see a price target for 2019 of $58.  So I do see about a 10% upside possibility if the markets can find reason to be hopeful of growth.  If not, I find it hard to see the stock above my initial selling price of $55.25 any time soon.

Notes:
Stock Ratings: 1 = buy at current stock prices, 2 = buy on a 5-10% dip in stock price, 3 = sell on a 5-10% increase in stock price, 4 = sell at current stock prices to raise cash.  Ratings are based upon 12-18 month outlook on stock direction and not necessarily related to moves I make due to financial positioning.

Nothing on this site should be taken as advice, research, or an invitation to buy or sell any securities.  All views expressed are solely of my own and I am not a professional money manager.  Please consult with your financial adviser before taking any action in your own portfolio.