Description

I am recommending a long position in Cedar Fair, L.P. (FUN) at a price of $43 per share. I believe the company is worth ~$55 one year from now, or 34% upside from the current stock price (including distributions). FUN has a market capitalization of $2.4 billion and trades approximately $8 million a day. Please refer to piggybanker’s excellent write-up on the company written in April of last year for additional background. All his company background and thesis points remain true, so I will just give a quick reminder of the key business attributes and provide an update on some recent developments.

Cedar Fair is the owner/operator of 16 regional amusement and water parks across the United States. Some of its major parks include Cedar Point in Sandusky, OH, Canada’s Wonderland in Toronto, Canada, King’s Island in Cincinnati, OH and Knott’s Berry Farm in Buena Park, CA. Such parks enjoy several attractive business characteristics, including long, local operating histories and customer loyalty, an attractive price per hour of entertainment value, proven economic resilience, and opportunities to enhance pricing and in-park spending. Given the enormous capital, environmental and other hurdles of building new theme parks from scratch, they are unlikely to face new competition in their localities in the foreseeable future. In addition, digital technology is not a viable substitute for the outdoor theme park experience, as it is with so many other forms of entertainment. For all the above reasons, we believe theme parks operate as stable, quasi-regional monopolies that have strong pricing power. With a capital-disciplined management at the helm, these companies can continually enhance their attractions and still generate substantial free cash flow. We believe Cedar Fair possesses all of these qualities.

The units are valued at 12.3x my estimate of 2013 FCF of $3.48/share and offer a 6% distribution yield. We believe the business can grow FCF in the mid to high single digit % range over the medium term, and unlike most other MLPs, does not require additional debt or equity capital to continually increase its distribution. In addition, the company has an opportunity to meaningfully reduce their interest expense when some expensive debt begins to be callable next year. My FCF/unit estimates for 2014 and 2015 are $3.93 and $4.23, respectively (2015 has the first full year’s benefit of the refinancing). Pro forma for a full year’s benefit from a refinancing, my 2014 FCF/unit would be $4.09.  I get to my target price by applying a 13.5x multiple to my pro forma 2014 FCF/unit estimate. For 2015, I estimate the dividend to be $3.60/unit, which would represent a 6.5% yield off of my target price.

Summary Financials

The company’s current distribution is set at an annualized rate of $2.50 per share, which represents a payout ratio of just over 70% of 2013 distributable free cash flow.  The company has indicated that this payout ratio has room to go higher, as the company continues to build some extra cash reserves in the event of another significant downturn.  The uses of the above FCF are quite simple:  distributions and some very modest debt pay-down each year.  I estimate that the payout ratio increases to 80% in 2014 and 85% in 2015, which gets to my 2015 distribution estimate of $3.60/unit.  With these assumptions, I still have cash accumulating on the balance sheet; by the end of 2015, I have a cash balance of $154 million, compared to $79 million at the end of 2012.  Leverage is manageable:  net debt / EBITDA will be 3.3x at the end of this year, declining modestly to 2.8x by 2015.  I also believe there is a fairly high likelihood that management uses some of that growing cash balance to repurchase units – they have indicated that possibility in their most recent analyst day (quite the rarity for an MLP to be retiring shares.)  I don’t think it will be a game-changer, but it show’s management’s conviction in the business and its belief that the units are undervalued.   

As a side note, I think FUN’s performance in 2009 was admirable as EBITDA only declined by 11% and more than fully recovered the following year, especially considering that the entire 2009 season suffered from very bad weather which exacerbated results.     

Recent Results

Despite a resilient top line, one of the less inspiring aspects of FUN’s performance has been the lack of operating leverage. In 2011 and 2012, revenue grew by 5% and 4%, respectively, largely driven by increased per-capita spend (i.e. pricing). During the same periods, EBITDA only grew by 4% each year. Management has acknowledged that there should be operating leverage given the relatively-high fixed cost nature of operating theme parks and has made it a focus item going forward. For the first half of 2013, signs of operating leverage are starting to emerge. Revenues are up 5% (again, largely on price) and EBITDA is up 19%. Management warned not to extrapolate the first half for the full year because there is some more investment spend planned for the back half (added CRM capabilities), but they did acknowledge there should be decent EBITDA margin growth for the full year 2013. In my model, I have revenue growing 5% and EBITDA growing by 9%.

One of the main drawbacks to investing in theme parks is the heavy dependence on weather. However, recent results also show FUN’s ability to ratchet down park operating expenses (within the hour) when adverse weather is expected to significantly affect that day’s attendance. In the most recent Q2, FUN’s attendance declined by 4.3% due to adverse weather and partially to an Easter timing shift. FUN was able to reduce operating expenses during the period by 3.4%. Such flexibility mitigates the impact of weather and further reinforces the stable nature of the business.

Near-term Catalyst

Cedar Fair has $405 million of 9.125% senior unsecured notes that mature in 2018 but are callable beginning 8/1/14. In February of this year, the company raised $500 million of new senior notes concurrent with a new bank facility. The new notes were priced at 5.25% and are currently yielding 5.72%. The company’s intention is to refinance the $405 million of senior notes on or before 8/1/14 (when the make-whole premium gets to a manageable level). The company will most likely choose to access the bank debt market to refinance the notes. In fact, its existing credit agreement has an accordion feature for $400 million which can be accessed for this purpose. The bank facility bears interest at LIBOR + 250 bps with a LIBOR floor of 75 bps. This refinancing could potentially allow for interest expense savings of $24 million, or $0.42 per unit. Based on my 2013 FCF/unit estimate of $3.48/unit, that is a FCF pick-up of 12%.  My estimates above assume they realize ~70% of this pick-up (rising interest rate environment, company may swap floating into fixed, etc.)

Risks

High amount of seasonality - FUN makes most of their money in the 2nd and 3rd quarters, plus the Halloween period. Given it is an outdoor concept, FUN’s results can be negatively affected by the weather.

Interest rates – Fears of rising rates have and could continue to impact people’s perceptions on the valuation of high-yielding stocks.  In this case, I believe there is a strong margin of safety based on a low, absolute valuation:  12.3x ’13 FCF / 10.9x ’14 FCF / 10.2x ’15 FCF.  The dividend yield I state is an output to my valuation process, not an input.  In addition, rising rates should have no impact on their growth trajectory, as FUN has no need to access debt/equity markets to fund further growth.

MLP risk – Cedar Fair is a grandfathered MLP which enjoys tax advantages relative to a traditional C-corp.  The company does pay some taxes, however.  Five of the company’s main parks were acquired from CBS back in 2006; based on the transaction structure, these parks do not fall under the partnership structure and therefore pay normal taxes.  In addition, back in 1987, as part of a deal for the company to remain grandfathered as an MLP, the company agreed to pay taxes in the amount of 3.5% of gross receipts (rev-COGS) from the partnership properties.  Late last year (post election), there was some fear that MLPs may be included in the broader discussion of tax reform as a way to eliminate tax loopholes. In FUN’s case, I actually think it may be a net positive if they decided to convert into a C-corp.  As I mentioned above, FUN is somewhat of a taxpayer already so the additional tax leakage is mitigated.  Based on some very crude math, I estimate that my 2015 FCF/unit would go down to $3.88 from $4.23 under a fully-taxed C-corp scenario.  That’s a clear negative, but I believe there is a high likelihood that FUN will enjoy a higher multiple as a C-corp that would more than offset the decline in FCF.  FUN trades at a significant discount to both Six Flags and Sea World, and being structured as an MLP is likely the main reason.  Many funds are precluded from buying MLPs, and the trading volume for FUN is a lot more muted.  For reference, SIX trades at 16x 2013 fully-taxed FCF and SEAS trades at 21x 2013 fully-taxed FCF (both these companies have sizeable NOLs so I fully tax their FCF and deduct from the trading price the present value of their NOLs.)      

No reliance, no update and use of information.  You may not rely on the information set forth in the above write-up 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 write-up does not purport to be complete on the topic addressed, and we do not intend to update the information contained therein, even in the event that the information becomes materially inaccurate.  Certain information contained in the write-up 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.  We now own the security discussed above, and may decide to buy or sell such securities at any time of our choosing without providing an update.

Catalyst