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Merlin Entertainments looks to regain the magic

Merlin Entertainments looks to regain the magic

Merlin Entertainments continues to feel the impact of the June 2015 roller coaster accident at Alton Towers.  The Midway Attractions division has also recently been impacted by weak European travel.  The longer-term outlook remains sound, though, with LEGOLAND Parks continuing to see robust trading.

Merlin Entertainments is the world’s second most visited attraction group with the Walt Disney Company in first place.  However, Disney has a range of other businesses, such as cable TV, and as such Merlin is the largest sector “pure play”.

Another feature of Merlin Entertainments is its diversification on a geographic basis and by the range of brands in its portfolio.  To keep the business fresh there is a Merlin Magic Making team tasked with designing and delivering new projects.

Two recently opened rides are Darren Brown’s Ghost Train (opened in July) at Thorpe Park and Galactica at Alton Towers (March).  A relatively new visitor attraction concept, meanwhile, is Shrek’s Adventure in London.

Merlin Entertainments: all about creating visitor magic

Source: Merlin Entertainments investor presentation

The three divisions at Merlin Entertainments are Resort Theme Parks, Midway Attractions and LEGOLAND Parks.  Midway Attractions operate indoor city centre sites and the other two divisions operate large theme parks.

For investors who like to sample a company’s product, Merlin has an overweight position in the UK.  Sites include LEGOLAND Windsor, Alton Towers, the London Eye, Madame Tussauds, Sea Life and The London Dungeons.

It is also in the UK, and to some extent Europe, where recent issues have impacted trading.  The June 2015 accident at Alton Towers hit Resort Theme Parks while the terrorist attacks in Europe in 2016 have hit Midway Attractions.

Merlin Entertainments has, however, proven to be a resilient business with the operating profit margin at a solid 12.2% in the first half of 2016.  The prospects for growth at LEGOLAND Parks continue to offer grounds for long-term optimism.

LEGOLAND Parks: reasons to be cheerful

An attractive business is one enjoying a market-leading brand with significant potential for growth.  To ensure that profit margins remain high there would also need to be a sustainable competitive advantage.

The privately held The Lego Group appears to fit this description and saw sales increase by 25% in 2015.  Over the last 12 years the average rate of revenue growth at The Lego Group has been an impressive 15%.

The popularity of Lego shows no signs of waning with revenue in the first half of 2016 up 10% in local currency terms.  The big screen opportunity supports the brand with the first Lego Movie in 2014 well received and a new movie due in early 2017.

Lego Batman Movie: set to boost the popularity of Lego

Source: Lego Batman website

While some toys may go out of fashion there appears to be little prospect of this happening with Lego.  The product is marketed as offering “playful learning” and has significant potential to tap into the growth in Asia’s middle class.

We view the LEGOLAND Parks division as the key investment attraction for Merlin Entertainments.  There are currently 6 LEGOLAND Parks and the group believes that there is scope for at least 25 resorts in the fullness of time.

Three of the current LEGOLAND Parks are in Europe and two are in the United States.  There is only one LEGOLAND Park in Asia but the group has plans to open sites in South Korea, Japan and China.

The smaller LEGOLAND Discovery Centers (LDC) occupy city centre locations and are part of the Midway Attractions division.  The first LEGOLAND Discovery Centre was opened in China (Shanghai) in April and has seen robust trading.

Source: Merlin Entertainments investor presentation

Merlin Entertainments results

Looking at Merlin’s financial results for the first half of 2016 and like-for-like sales fell by 1.1%.  This was driven by a 10.2% decline in like-for-like sales in the Resort Theme Parks division due to the Alton Towers accident in June 2015.

Midway Attractions saw a 0.2% like-for-like sales decline with tourist travel impacted by terrorist events in the first half of 2016.  LEGOLAND Parks, however, saw 3.3% like-for-like revenue growth in the period.

The rollout of Midway Attractions, and new accommodation at the group’s theme parks, offset weak like-for-like sales in H1 2016.  The group also benefited from an FX tailwind and this is set to continue given the decline in the pound.

 

Source: Merlin Entertainments investor presentation

While reported revenue improved by 5.3% to £573m in the first half the group saw profit before tax increase by only 0.9% to £70m.  Merlin Entertainments is a seasonal business with the second half the strongest trading period.

2016 Trading outlook

Turning to the full year outlook and it is now over a year since the Alton Towers accident.  The second half of 2016 is therefore likely to see a rebound in the Resort Theme Parks division.

Midway Attractions may continue to feel the effect of weak global tourist travel but this will be offset by new site openings.  LEGOLAND Parks should continue to trade well and will see a new site opening in Dubai in October and in Japan in April 2017.

Nick Varney, the CEO of Merlin Entertainments, stated alongside the interim results that:

“We are confident in the delivery of significant year on year profit growth, and anticipate full year earnings per share in line with current expectations.”

Summary and valuation

The geographic and brand diversification of Merlin Entertainments has allowed the group to offset recent headwinds.  LEGOLAND Parks has been the company’s profit engine with an operating margin at an impressive 26.9% in H1 2016.

The future for LEGOLAND Parks looks robust with the Lego Group continuing to report strong sales growth for the toy brand.  The opening of “The LEGO Batman Movie” next year will support the global appeal of Lego.

It is also encouraging that the recently opened LEGOLAND Discovery Centre (LDC) in China is performing well.  This suggests that the LEGOLAND Parks planned for China will receive a good response.

Merlin Entertainments is expensive against near-term earnings with the forecast P/E for 2016 a punchy 23.2X.  However, the current year saw a weak first half with two divisions experiencing a decline in like-for-like sales.

Turning to 2018 and the Resort Theme Parks division will be back at full strength and the two new LEGOLAND Parks will have had time to mature.  The forecast P/E for Merlin in 2018 therefore falls back to a more moderate 17.1X.

Merlin Entertainments offers a long-term growth story and is the only way to buy into the success of Lego.  As long as the toy brand continues to grow in popularity the investment attractions of Merlin will, in our view, remain in place.

This report was produced by Fat Prophets Senior Research Analyst, Andrew Latto



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