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As the Cineworld share price surges, should I buy?

Cineworld cinema

Cinemagoers tend to really enjoy plot twists, cliffhanger moments and sudden shocks. The same does not apply to cinema owners, though. Shareholders in Cineworld (LSE: CINE) have had a rollercoaster couple of years. And 2022 looks set to bring more of the same, with the Cineworld share price soaring over 20% yesterday. It’s still down 40% over the past year, at the time of writing this article earlier today. So could this be a buying opportunity for my portfolio?

Why did the Cineworld share price surge?

Such a large jump in a single day’s trading session is unusual. So, what was behind it?

There wasn’t any announcement yesterday from the company to trigger improved investor confidence. I think some traders have been reassessing what lies ahead for the chain and reckoning that 2022 could see brighter days for Cineworld.

Yesterday’s gain simply reclaims some of the value lost over the past month. In December, a Canadian court handed down a judgment against Cineworld that could cost it around £710m. That added to the chain’s existing woes and sent many investors heading for the exits.

But the company shouldn’t have to pay the bill while the appeal process is ongoing. If it appeals successfully, it may not have to pay it at all. So, while the judgment is definitely another headache for Cineworld management, in the short term it doesn’t necessarily bode badly for the company’s cash flows. Given Cineworld’s $8.4bn net debt at the end of its last financial year, free cash flow is the key focus for many shareholders right now.

Trading has been promising

To generate cash flow, Cineworld needs its cinemas to be open – and people paying to visit. Things have been improving on that front. In a November trading update, the company said that box office and concession revenues in October reached 90% of their pre-pandemic 2019 levels. If such a strong recovery is sustained, it could help generate sizeable free cash flow. This could be used to reduce debt to more manageable levels.

I don’t see any prospect of Cineworld restoring its dividend in the next couple of years. But if it can reduce debt, the shares could become more attractive again. After all, it is one of the leading cinema groups globally. Crucially, the October numbers show that the appetite to see films in cinema has returned for many customers. If that continues, Cineworld’s market position could make it profitable. Set against that, the current market capitalisation of under half a billion pounds might look cheap a couple of years from now. So I think yesterday’s share price surge was driven in part by bargain hunters thinking about what could happen in 2022.

Cineworld risks

Despite that, there is no way I will be adding Cineworld to my portfolio right now.

I do think potential returns could be juicy if things work out. But I see large risks. Even if cinema visits were at normal levels, $8.4bn is a huge net debt for a company of Cineworld’s market cap. Servicing the debt and repaying it will require large financial efforts in coming years. If free cash flow proves insufficient, the shares could go to zero. Added to that, further restrictions in some markets and the growth of streaming new films could both hurt revenues and profitability.

The post As the Cineworld share price surges, should I buy? appeared first on The Motley Fool UK.

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Christopher Ruane 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.