AMC (NYSE:AMC) announced the appointment of CEO Adam Aron to the additional position of Chairman of the Board on July 21. Before you run out to buy AMC stock on the news, you might want to do a stress test on America’s largest movie theater chain.
You might not like what you find.
As regular readers may know, I live on Canada’s East Coast, in the beautiful city of Halifax.
Born and bred in Toronto, one of Canada’s most expensive cities for owning real estate, the mortgage stress test has become a weapon for The Office of the Superintendent of Financial Institutions — an independent agency of the Government of Canada — to slow down rapidly increasing residential real estate prices.
On June 1, new mortgage stress test rules took effect in Canada.
Essentially, anyone applying for a new uninsured mortgage or renewing their existing one has to show that they could afford an increase of two percentage points above their contracted rate, or 5.25%, whichever is higher. Previously, the benchmark was 4.79%.
So, let’s say I can get a mortgage from my local bank for 3%. I’ve got to show I can afford to pay interest calculated on 5.25%, not 3%.
In the future, should I need to renew my mortgage and the renewal rate has increased to 4%, I’ve got to show I can afford to pay interest based on a 6% rate, not 4% or the 5.25% benchmark.
It got me thinking: What if AMC had to live by this kind of debt stress test. Could it survive a 2% bump on the interest it’s charged on its long-term debt?
Let’s consider the question.
A Closer Look at AMC Stock
- Current maturities of corporate borrowings = $20.0 million
- Corporate borrowings, or long-term debt = $5.44 billion.
The total comes to $5.46 billion. At this point, you might be wondering how Morningstar.com came to the higher figure of $11.05 billion.
Well, several years ago, the Financial Accounting Standards Board (FASB) introduced ASU 2016.02 that requires companies to account for their operating lease liabilities on their balance sheet.
- Current maturities of finance lease liabilities = $12.5 million
- Current maturities of operating lease liabilities = $591.1 million
- Finance lease liabilities = $77.8 million
- Operating lease liabilities = $4.91 billion
This brings total debt to $11.05 billion. CNBC does a good job explaining the change in a February 2019 article. It reported that the change added $3 trillion in liabilities to corporate balance sheets.
In AMC’s case, it doubles the company’s outstanding financial obligations.
So, even though it continues to sell its shares through at-the-market offerings, it continues to have a massive noose around its neck from these obligations.
In the first quarter, AMC had an interest expense of $162.8 million, almost double the amount in Q1 2020.
The increase occurred for several reasons, including that AMC has issued a bunch of debt at interest rates between 10% and 17%. Note 6, found on page 19 of its 10-Q, lays out its corporate borrowings and finance lease obligations.
The two largest pieces of its debt situation are its credit facility — $1.96 billion at 3.195% — and $1.42 billion in Second Lien Subordinated Notes at 10% for cash and 12% in kind.
The following page points out that almost 75% of its long-term debt comes due in 2026. So it’s either got to get its cash flow generating at pre-Covid levels, or it likely will find itself in bankruptcy court.
Back to the Stress Test
Now imagine the interest rate on AMC’s credit facility jumped by two percentage points to 5.195%.
On almost $2 billion in debt, you’re talking about a 63% increase in annual interest payments on that term loan [$103.9 million in interest (5.195%) less $63.9 million in interest (3.195%) divided by $63.9 million].
And you’ve still got more than $3.5 billion in debt to restructure at a theoretical increase of two percentage points.
That doesn’t consider the $5.6 billion in operating lease payments and financing lease payments due in the future. Of those, between 2021 and 2026, AMC has payments of approximately $3.2 billion [$5.0 billion less 36% for imputed interest].
While the board has just elected Adam Aron as its Chairman, the CEO has been in the top job since 2016. He’s had plenty of time to fix AMC’s problems. Giving him an additional title is not going to get the job done.
Wanda Group was smart to get out while it still could. Reddit buyers better hope a stress test isn’t in AMC’s future. It would likely fail that test. The company’s Altman Z-Score is currently -0.62. Anything below 1.81 indicates a company is in possible distress.
Its day of reckoning is coming.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.