SeaWorld Shares May Have A REIT Conversion Priced In: Citi

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Citi analysts initiated coverage this week on SeaWorld Entertainment Inc (NYSE:SEAS) with a $42 per share price target and a neutral rating. As of this writing, the stock was down 2.94 percent in early Wednesday morning trading.

SeaWorld Shares May Have A REIT Conversion Priced In: Citi

Citi analyst Jason B Bazinet issued a report to investors today taking a closer look at the current stock price of SeaWorld. He covered the common complaints Wall Street has with theme parks and said currently his estimations seem to indicate that investors are factoring in a conversion to a real estate investment trust (REIT) in the company’s near future. However, he thinks it’s too early to suggest that such a conversion will occur in the near term.

Common Complaints Pertaining To SeaWorld

The two major complaints listed by Bazinet are the cyclical nature and the capital intensiveness of the theme park business. He admits that theme parks are indeed cyclical in nature. SeaWorld Entertainment Inc (NYSE:SEAS) saw its revenues fall approximately 5 to 6 percent in the most recent recession, which was a typical performance of theme parks during that time frame.

He also took a closer look at the return on invested capital for both SeaWorld and Disney’s Parks unit. He found that both parks generated returns in the mid-single digit range over the last five years.

The Potential Positives For SeaWorld

The Citi analyst pointed out that stocks tend to trade on the future trajectory of cash flows, which points to macro-economic trends and recent capital investments. Specifically, he examined in-bound airline passenger traffic to Orlando, which is SeaWorld’s biggest market. He found that the traffic was only growing nominally.

On the other hand though, SeaWorld Entertainment Inc (NYSE:SEAS)’s recent capital investments have surged, which he said may mean that the company will see 4 to 5 percent attendance growth this year.

Healthy attendance growth, plus margin expansion of earnings before interest and taxes, reduced interest costs, share buybacks, and falling capital investments, will likely mean good things for the company’s free cash flow. The analyst predicts that untaxed free cash flow will ramp significantly from $1.34 per share last year to $2.05 per share this year and $2.82 per share the following year.

But What About The REIT Conversion?

After completing his calculations, Bazinet said it appears that Wall Street may be looking forward to a REIT conversion in SeaWorld Entertainment Inc (NYSE:SEAS)’s near future. There has been a recent trend in REIT conversions as numerous companies take advantage of the structure to avoid double taxation, so it makes sense that investors would expect it.

Because of significant net operating losses, SeaWorld’s reported free cash flow per share isn’t fully taxed. Therefore, the stock’s current value, which is around $38 per share, is 19 times the company’s expected 2014 fully-taxed free cash flow. However, it’s only 13.5 times the company’s untaxed free cash flow, which is “more reasonable.”

The analyst said it’s likely that Wall Street is incorporating a REIT conversion into its valuation because it would eliminate most of the company’s corporate tax. However, he believes that a conversion, if it happens at all, “is likely several years away,” possibly after the company’s net operating losses are exhausted in 2017.

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