Are shares in Village Roadshow Ltd cheap?

Since the start of May, shares in Village Roadshow Ltd (ASX: VRL) have trended downwards despite a lack of company specific news. At the same time, competitor Ardent Leisure Group’s (ASX: AAD) shares have risen almost 10% over the same period, indicating the market might be missing something important about Village Roadshow.

What’s changed?

In March this year, I wrote about why I believed Village Roadshow was a buy here. The key take away was that Village Roadshow’s performance for the first-half of 2016 was average, but that management’s renewed focus on streamlining the existing business could work wonders if executed correctly.

Three months on, and without knowing anything more on management’s progress, I still believe Village Roadshow is a buy for one additional reason that didn’t exist in March.

Lower for longer

The Reserve Bank of Australia (RBA) boss — Glenn Stevens — signalled on Monday that the RBA would continue to set monetary policy in accordance with Australia’s annual inflation target of 2%-3%.

With Australia’s most recent quarterly inflation figures revealing the inflation target is at risk of being missed this year, it is apparent that the RBA will do more to stimulate growth. The first measure has already been provided through an interest rate cut earlier this month.

Although it’s unclear whether the RBA will cut rates again, it is likely that the interest rate isn’t headed higher anytime soon. This makes Village Roadshow’s fully-franked trailing yield of 5.5% (7.8% with franking credits) Nirvana for income-seeking investors. Importantly, Village Roadshow’s current earnings should sustain this dividend, meaning there isn’t too high a risk of it not being maintained.

Earnings profile

As seen in Ardent Leisure’s share price, earnings remain robust in the entertainment sector with lower rates fuelling tourism and discretionary spend in Australia. This augurs well for Village Roadshow given its arguably more leveraged to Australian tourism and discretionary spending than the former.

Additionally, like Ardent Leisure, Village Roadshow has a strong footprint in America where rising interest rates and a strengthening economy are likely to buoy earnings. These effects should be compounded when translated to Australian dollars given the dichotomous direction of the Australian and U.S. currencies.

Cherry on top

The kicker for Village Roadshow is that management has already indicated an intention to pay a special dividend of 10 cents in the 2017 financial year (whilst maintaining its current payout). This would push the yield higher, possibly leading to a re-rating in share price.

Foolish takeaway

Whilst it can’t be guaranteed that this is the bottom for Village Roadshow shares, macro-economic conditions favour its business model and should support its current share price going forward.

Although a hurdle for share price growth will be management’s ability to turnaround earnings in the second half, I believe a purchase at current prices should not see too much attrition in value.

 A better bet?

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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