Description

I am recommending Cedar Fair (FUN / $49) as a short.  I originally wrote up FUN as a long back in 2014, and I continue to believe that the business/industry is relatively attractive, and therefore this is more of a medium-term trading call.  Bottom-line, I believe the company has been irresponsible in committing to grow its distribution by 4% per year. Pro forma for recent transactions, the company is levered 4.1x EBITDA and has a payout ratio of ~140%.  In addition, I believe management is slow to acknowledge some incremental headwinds to the business that management lazily blames on bad weather. I believe they will need to cut their distribution to a level closer to $2 (vs the current $3.70).  If that happened, I believe the stock will trade down to the low $30s (-33% from here).

Brief company background:

• One of the largest amusement park operators in the world, owning 11 amusement parks, 2 separately gated outdoor water parks, 1 indoor water park and 4 hotels.

• Key parks include: Cedar Point (Sandusky, OH); Knott’s Berry Farm (Anaheim, CA); Canada’s Wonderland (Toronto, Canada); Kings Island (near Cincinnati, OH); Carowinds (Charlotte, NC); Dorney Park and Wildwater Kingdom (Allentown, PA); Kings Dominion (near Richmond, VA); California’s Great America (Santa Clara, CA); Valleyfair (near Minneapolis/St. Paul, MN); Worlds of Fun (Kansas City, MO)

• 26 mm guests annually

• 850+ rides and attractions / 115+ roller coasters / 1,600+ hotel rooms

• Grandfathered MLP, but roughly half of business taxed as regular c-corp (Paramount acquisition before the GFC) – overall 20% cash tax rate

I wrote up FUN as a long back in 2013, and continue to think that amusement parks are solid businesses benefiting from strong barriers to entry and an attractive consumer value proposition.  Coming out of the GFC in 2009, the industry has done an admirable job (led by Six Flags) in methodically raising prices (less discounting), shoring up their balance sheets, and returning a greater proportion of FCF via dividends/distributions.  However, I believe this playbook is largely done. For Cedar Fair, EBITDA hit a peak in 2016 at $481 mm, and has declined to $479 mm in 2017 and $468 mm in 2018. This is despite spending ~$30-40 mm per year in “growth capex” in both 2017 and 2018.  The company, as well as sell-side analysts, are quick to blame weather for the recent underperformance. I believe there are other, more structural factors at work that will make the next 5 years more difficult than the last 5 years.

First, I believe the industry is bumping their heads a bit with pricing.  There have been continual increases since coming out of 2009, and I believe it will be much more difficult to generate incremental value from continued price increases.

Cedar’s Fair “In Park” spend per capita has flattened out in the past two years after a nice run of growth since 2011:

Perhaps it’s partially due to the higher prices, but I also believe the amusement park consumer is behaving a bit differently than in years’ past.  SIX and FUN sometimes refer to this by mentioning the increasingly busy schedules of families, where it has become more difficult to schedule a time to visit the park, given competing commitments of family members (e.g. other hobbies, travel little league, etc.)  The industry would historically state that “weather tends to even itself out.” If a family’s visit in June gets rained out, the same family will choose another weekend in July to make it up. Jim Reid Anderson, by the end of his tenure at CEO of Six Flags, admitted that this isn’t the case anymore.  A lost visit in June/July is often not made up by the end of the season.

In defense of the health of its business, Cedar Fair executives would often state, “when the weather is good, people are coming to the park and spending more”.  That statement most likely is true, but it does not address the question of what are consumers doing when the weather is not as good? In recent years, attendance during the “not so good” days are far worse than they have been historically.  People are equipped with real-time, hourly weather apps, and given the increased cost for a family of four to spend a day at the park, a family is more reluctant to take their chances and commit if the weather is iffy. That, coupled with an ever increasing amount of competing alternatives for families’ time, leads to attendance on a drizzly Saturday to be much worse than it would have been a few years ago.  (As a random aside, I feel that these weather apps definitely err on the side of caution when forecasting hourly weather. I’ve found countless times that the hourly forecasts call for rain, when in fact, the weather is sunny).

Q2 2018 Earnings Conference Call:

The annual attendance figures shown above look decent in 2017 and 2018, but those years benefited greatly from the introduction of new winter holiday events.  If you look at YTD 2017 and 2018 through the core summer season, the attendance has been more challenging. It was -1% in 2017 and -1.5% in 2018. If the above factors persist, which I believe they will, it’s hard for me to envision a sharp snap-back in performance from the past two years of negative growth.

The other growing headwind is inflation.  Seasonal labor is 40% of their overall cost structure, and inflation for this line item has been trending up MSD % in recent years with no signs of abating.  If the other 60% (corporate overhead, maintenance, etc.) grows at a more modest 3% per year, overall opex will grow 5% for the foreseeable future. When all cylinders are firing, a good revenue growth year would be 3-4%, so I believe it will be difficult for FUN to maintain their margins over the medium term.

Despite these incremental headwinds and two years of bad operating performance and unproductive growth capex, the company stubbornly has committed to raising their distribution 4% annually.  The payout ratio (Distributions/FCF) has ballooned from 44% in 2011 to 137% in 2017 and 127% in 2018 (financials are below).  One reason why management felt emboldened to continue raising the dividend was that they had a decent cash balance upon which to draw from.  The company sold some assets in the 2014 time period, which brought the cash balance over $100 mm, and in 2017, the company issued more debt as they found the capital markets very favorable.

It’s also worth mentioning that the company has put out its latest EBITDA target, projecting a 4% CAGR between now and 2023, so the underlying belief is that the company will eventually “grow” out of its unhealthy payout ratio.  As I referred to above, I believe management is blaming bad weather for more structural headwinds and is being far too optimistic. And for what it’s worth, the company has never once (in my 7 years of following the company) been able to hit any of their financial targets.  The company originally set out a greater than $500 mm EBITDA target for 2018 (3.3% CAGR vs. 2013), then adjusted it mid way, saying that it will hit it at least one year earlier than 2018. It came as close as $481 mm in 2016 before going backwards the following 2 years to end 2018 at $468 mm.    

In the past week, the Company announced the acquisition of two waterparks in New Braunfels and Galveston, TX from Schlitterbahn.  The purchase price was $261 mm. Actual EBITDA was not disclosed, but commentary said that the company hopes to get the waterpark EBITDA margins to corporate level margins (~35%) within two years.  For an estimate, I penciled in a 30% EBITDA margin for now. That implies a 12.8x EV/EBITDA multiple. Synergies are limited as the company has no operations in TX currently. Doesn’t seem to be a great deal, at least financially.  In addition, earlier in March, the Company agreed to buy the land underlying its Great America park in Santa Clara, CA for $150 mm. Rent savings will be $6-7 mm per year. To pay for all this, the Company just issued $500 mm of new senior notes at 5.25%.  Pro forma for all these transactions, the Company has pro forma leverage (net debt/EBITDA) of 4.1x.

If operating costs are growing 5%, the company needs to grow revenues over 3% to stay flat at the EBITDA level.  That’s why I keep PF EBITDA flat in 2019. I’m also not giving the company credit for any benefit from developing the land at Santa Clara.  Presumably any tangible benefit will be many, many years out, and management hasn’t had the best track record of generating incremental benefit from their recent growth capex initiatives.  In sum, FUN is now levered > 4x and has a PF payout ratio of approaching 140%. This doesn’t feel like a good capital allocation policy, particularly where we are in the economic cycle. In the prior downturn, EBITDA fell by 11% (with help from aggressive cost cutting).  All the numbers are below, but based on my projections, the company will nearly deplete its entire cash balance by the end of this year to pay the distributions and will need to start borrowing to pay the distribution.

I think it’s a matter of time before the company needs to cut its distribution.  I feel a more prudent reset will be to $2.15, a 43% reduction from the distribution implied for 2019.  Based on my math, that would be an 80% payout ratio off of PF FCF and would be adequate to cover the FCF in the event of a downturn.  Should this happen, I think the units would trade down to the low $30s, implying a ~6% yield off the new distribution. It would still be 4x levered, at the tail end of an economic cycle.  At $33, that would imply an 8x EV/EBITDA and 13x EV/EBITDA-Capex.

Risks:

• I’m overstating the structural headwinds creeping into the industry, and weather in 2016 and 2017 were indeed anomalous years, and results snap back significantly in 2019 and beyond.

• Acquisition by Six Flags or an international player

• At the current distribution, the units yield 7.5%, so it’s a bit expensive to short

No reliance, no update and use of information. You may not rely on the information set forth in the above write­up as the basis upon which you make an investment decision. To the extent that you rely on such information, you do so at your own risk. The write­up does not purport to be complete on the topic addressed, and I do not intend to update the information contained therein, even in the event that the information becomes materially inaccurate. Certain information contained in the write­up includes calculations or projections that been prepared internally; use of a different method for preparing such calculations or projections may lead to different results and such differences may be material.

Catalyst

• Distribution cut (most likely at the end of 2019)