Merlin Entertainments (MERL) – Rollercoaster for shareholders may have opened a value opportunity
Shares in Merlin Entertainments took another tumble this week, dropping 8% after a disappointing trading update (latest share price 340.7p, market cap £3,482 million).
It has been a tough few years for shareholders. The share price reached a high c. 540p in 2017 but has fallen sharply since then in response to terror attacks, “unprecedented levels of demand volatility”, and downgrades to the company’s long-term growth expectations.
It makes for an unpleasant backdrop but it’s often in grim situations such as this that a value opportunity can arise. Let’s not forget that Merlin is still the second-biggest attractions group in the world, second only to Disney ($DIS).
The company has three divisions: Resort Theme Parks (six major sites including Alton Towers & Thorpe Park), LEGOLAND Parks and Midway Attractions (includes Madame Tuassauds, The Dungeons, Blackpool Tower, LEGOLAND Discovery Centres, etc).
In the 40 weeks to 6 October 2018, Merlin managed to grind out organic revenue growth on a like-for-like basis of 1.4%. The existing estate produced lukewarm figures with LEGOLAND parks (minus 0.3%) and Midway (minus 0.7%) each showing small declines in like-for-like revenue.Taking inflation into account, overall like-for-like revenue is flat or marginally falling.
When you include the contribution from new attractions, the total revenue growth was more encouraging at 4.7% (at constant FX). But of course the new attractions come at a heavy cost in terms of capital expenditure.
Where the company is growing is with its strategic move into hotel accommodation, opening 644 LEGOLAND rooms in Japan, California and Germany so that the group now operates over 4,000 rooms in total (Alton Towers is still the largest hotel site). Accommodation is likely to be a lower-risk, lower-return form of investment, compared to Merlin’s other activities.
The other growth effort is in Midway with the addition of two new attractions: The Bear Grylls Adventure in Birmingham and Peppa Pig World of Play in Shanghai.
The market was disappointed by this update, but it’s not all bad.
Firstly, negative trends in family tourism arising from terror attacks may be lifting, at least in the short-term. CEO Nick Varney commented as follows:
The impact of terror attacks which adversely affected performance from early 2017 has started to abate and we have seen early signs of recovery in the London tourism market over the summer.
Secondly, management considered trading to be in line with expectations, so there is still a chance that Merlin can hit its full-year numbers. That said, the risk looks skewed to the downside in this regard:
Trading to date has been in line with expectations, although there remain a number of important trading weeks over the Halloween and Christmas periods.
These are tough times for Merlin as it faces cost pressures (especially wages) and unstable demand. Despite this, it has some classic brands in its stable, most of which should prove to be valuable for many decades ahead.
The important role of its cornerstone investor, the Danish family behind LEGO, should also be mentioned. This family offers an important sense of stewardship and long-term thinking to the company, owning almost 30% of the company.
Returns will never be spectacular, as theme parks and accommodation are capital-intensive businesses. The group’s return on capital is in the region of 10%, and with the help of some leverage the return on equity is a little higher at 12% – 14% (depending on how you measure it).
On the other hand, at a forward P/E multiple of 15x (FY 2019 forecast EPS is 22.4p), there is not much growth priced in. Given how much the share price has fallen, investors around the current level may find that their rollercoaster experience is surprisingly pleasant! Worth looking into in more detail, we think.