Inox Leisure: Valuation gap versus PVR to reduce

Analysts believe Inox should trade at 15-20% discount to PVR on a one-year forward price/earnings as well as EV to EBITDA basis

Inox Leisure (Inox), India’s second-largest multiplex company, has historically traded at discounted valuations to PVR. Larger size of PVR versus Inox is one reason for this discount. For FY15, PVR’s revenues stood at Rs 1,481 crore, which is nearly 1.5 times higher than Inox’s revenues of Rs 1,017 crore. Strong presence of PVR multiplexes in premium locations is another reason.

Analysts believe Inox should trade at 15-20 per cent discount to PVR on a one-year forward price/earnings as well as enterprise value (EV) to earnings before interest, taxes, depreciation and amortisation (Ebitda) basis.

However, this valuation discount, according to consensus estimates, has widened significantly and currently stands at 31 per cent on FY17 estimated price/earnings basis and 27 per cent on FY17 estimated EV/Ebitda basis.

Brokerages such as Motilal Oswal Securities (MOSL) peg the discount higher. While the Street looks at one-year forward price/earnings ratio of these companies, some analysts believe it is more prudent to look at their EV/Ebitda given that they are in expansion mode and the fact that this metric also captures the debt on the books of both these companies. So while PVR trades at FY17 estimated EV/Ebitda of 10.4 times, this metric stands at 7.6 times for Inox. Most analysts believe this valuation discount should narrow going forward in the presence of a host of catalysts for Inox.

Niket Shah of MOSL, says: “We believe Inox should trade at about 20 per cent discount to PVR. We expect that advertisement revenues will grow at a faster pace for Inox as compared to PVR going forward and will drive Inox’s valuations.” He expects Inox’s ad revenues to grow at 40-50 per cent over the next two years, while that of PVR will be at 30 per cent. Notably, this metric forms 10-12 per cent of both the companies’ annual revenues.

Inox’s balance sheet appears to be stronger than that of PVR given that its debt/equity stood at 0.4 times in FY15 versus PVR’s 1.6 times. PVR is also looking at raising further debt to fund the acquisition of DT Cinemas, which means its debt/equity ratio could inch up further.

Inox acquired Satyam Cineplex in July 2014 and merged the company with itself in January 2015. The June 2015 quarter will reflect full quarter financials of Satyam and will have a positive rub off on Inox’s results in the quarter. Apart from boosting Inox’s presence in northern India, Satyam will also aid Inox’s average ticket prices (ATP) as Satyam’s ATP are higher than that of Inox. Also, most of Satyam’s properties are located in premium areas and hence offer scope for improvement in ATP and revenues from food and beverages. These positives will lead to convergence in valuations of Inox and PVR going forward.

“We expect Inox’ ATPs to grow at 6.4 per cent CAGR (compounded annual growth rate) in FY15-17 to Rs 185.7 by FY17 on account of strong movie line-up such as Dil Dhadakne Do, ABCD 2, Bajrangi Bhaijaan, among others. Moreover, we believe the spend per head (SPH) will expand to Rs 63 by FY17 from Rs 59 in FY15,” writes Karan Mittal of ICICI Direct in a recent report on the company. Consequently, analysts expect Inox’s Ebitda margin to expand by 150 basis points and 80 basis points in FY16 and FY17, respectively.

Inox owns seven to eight real estate properties in prime locations with market value of about Rs 400 crore versus book value of Rs 150 crore. The company might sell these properties in the long run, which in turn will lead to higher return ratios as it will enable Inox to retire its debt.

In this backdrop, most analysts polled by Bloomberg remain positive on Inox Leisure and their average target price of Rs 215.5 indicates an upside of 27 per cent from current market price. In comparison, the upside potential for PVR scrip stands at about 15 per cent given the average target price of Rs 744 a share. However, subdued performance by movies at the Box Office remains a key downside risk.