The AMC Entertainment (NYSE:AMC) stock price continues to defy expectations. Despite the poor state of the firm’s financials, the meme stock has risen over 580% during the last 12 months. It recently published its second-quarter earnings report, which showed some signs of improvement. But is it enough to justify a $19bn market capitalisation? Or is AMC’s stock price about to collapse? Let’s take a closer look.
A path to recovery emerges
It’s no secret that Covid-19 has decimated the hospitality and entertainment sectors. AMC was one of many businesses forced to close its doors to customers to help prevent the spread of infection. As a result, the already debt-ridden company found itself with bills to pay and no cash flow to cover them. So AMC’s stock price crashed in March 2020.
But thanks to the vaccine rollout, cinemas are reopening. And according to its latest earnings report, there are some positive signs of recovery. After more than a year in confinement, approximately 22 million individuals enjoyed the big-screen experience at AMC’s cinemas during the second quarter of 2021. Consequently, the company was able to generate gross income of just over $444m. That’s up from $18.9m during the same time last year.
What’s more, this increase in cash flow resulted in total losses for the period around $217m lower than in 2020. And the management team announced that becoming cash flow positive by the end of 2021 might be possible.
This would obviously be fantastic news for AMC and its stock price. But a recovery is far from certain. The meme stock has an exceptional level of expectations driving it today. And there remain several prominent issues that could send speculators running for the hills over the long term.
The AMC stock price bubble
Despite what the impressive performance of AMC’s stock price suggests, this business is not a healthy one. After years of employing an acquisitive growth strategy, the level of debt has risen considerably. In fact, this is one of the main reasons why the meme stock fell three years in a row before the pandemic had even entered the picture.
With the need for additional funding last year, the degree of financial leverage continued to rise as new loans were taken out. Total debt now sits around $5.6bn. And where there is debt, there is interest. With no positive cash flow, the company is burning through its resources to ensure that bills are paid on time.
According to the latest report, AMC has around $1.8bn of cash on its balance sheet. That undoubtedly creates some breathing space. But the money was raised through both additional loans and aggressive equity issues. Since 2019, the total number of shares outstanding has gone from 110 million to just over 513 million. That’s an 80% dilution effect that the current AMC stock price has decided to ignore.
Even if AMC can return to pre-pandemic levels of profitability, almost all the underlying profits will be gobbled up by interest payments. And the rest now needs to be split across 400 million additional shares. The idea that AMC’s current stock price can be justified by the prospect of the recovery of the entertainment industry seems delusional to me. Needless to say, I won’t be adding this stock to my portfolio anytime soon.
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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.