Merlin mullered after missing forecasts as terror attacks weigh
By Josh White
Date: Tuesday 17 Oct 2017
(ShareCast News) - Madame Tussauds and Legoland operator Merlin Entertainments disappointed with an update on its trading performance for the year to date, including the key summer period of July and August, taking the shine of new partnerships with Peppa Pig and Bear Grylls.
The FTSE 100 company revealed like-for-like revenue growth of just 0.3% for the quarter due to "difficult" summer trading at its London midway attractions and European theme parks, as a result of recent terror attacks and unfavourable weather.
Recent consensus forecasts had Merlin's like-for-like growth at 2.6% for the quarter, with a year-to-date consensus of 3.2%.
Merlin said the outlook for London was expected to depress earnings "for the foreseeable future".
Over the first 40 weeks of the year Merlin said that revenue growth of 12.4%, or 5.9% at constant currencies, reflected the "diverse nature" of its portfolio, and was driven by "strong" new business development - including the successful opening of Legoland in Japan, five new Midway attractions and 381 new accommodation rooms.
On a divisional basis, revenue growth was 7.7% at midway attractions, or 1.6% at constant currencies, while Legoland Parks revenue was ahead 24.4%, or 15.7% at constant currencies.
Merlin's resort theme parks saw revenue improve 3.4% at actual exchange rates, although at constant currencies revenue there was down 0.8%.
VOLATILE MARKET, BUT MAGIC FROM BEAR AND PIG
It confirmed its intention to reallocate its capital investment in a bid to address the "ongoing volatile market environment" and underlying cost pressures, reducing its existing estate capital expenditure by £100m over the 2018-2021 period, which would fund accelerated investment in the firm's accommodation and its 'productivity agenda'.
Merlin also announced two new intellectual property partnerships - 'The Bear Grylls Adventure' attraction, and a partnership with Entertainment One to roll-out location-based entertainment based on the 'Peppa Pig' children's entertainment brand.
Legoland New York was now expected to open in 2020, the board said, subject to final formalities, representing a total capital cost of around $350m (£262m).
"Merlin has delivered another period of good total revenue growth reflecting the contribution from new business development as well as more favourable currency movements, with over 70% of profits being derived from outside the UK," said chief executive Nick Varney.
"Another busy year has seen us open five new Midway attractions to date, nearly 400 accommodation rooms across four of our theme parks, and a new Legoland park in Japan.
"The exciting new partnerships with eOne and Bear Grylls, as well as the planned opening of Legoland New York in 2020, show there is plenty more magic to come."
In the existing estate, Varney described trading to date as being "more mixed".
After strong early season momentum across most of its businesses, he said Merlin experienced difficult trading over the summer period, as the spate of terror attacks witnessed in the UK marked an "inflection point" in Midway London and UK theme park trading.
Poor weather in Northern Europe and extreme weather in Italy and Florida also impacted peak season trading, he added.
"Despite the diversity of our business - by geography, brand and visitor mix - our markets continue to be impacted by certain external shocks, not least terrorism which is currently at record levels of intensity in Europe.
"We also continue to face significant cost pressures, largely brought about by employment legislation, particularly in the UK."
Though it was felt too early to predict the outlook for 2018, he said the recent trends experienced in London "will persist for the foreseeable future".
CAPITAL REDIRECTED
Varney said that going forward as a result, whilst the company's long-standing 'six strategic growth drivers' remained unchanged, reflecting the longer term structural attractiveness of the markets in which Merlin operates, the board would be reallocating capital to adjust to the current environment and to maintain its capital discipline.
"Over the period of 2018-21, we will reduce existing estate capex by approximately £100m, reallocating this into accelerating our highly successful accommodation roll-out programme, as well as increasing our investment in our productivity agenda.
"As a result, we expect a stronger contribution from new business development to offset an assumption of low single digit like for like growth, based upon similar aggregate levels of capital investment."
Varney said Merlin had experienced unprecedented levels of demand volatility in recent periods, adding that it was testament to the diversity of the portfolio, the strength of its brands, and the commitment of its team that it had continued to deliver revenue and profit growth.
"Our business model allows us to 'adjust the tiller' given the difficult market conditions and we are doing so.
"I and Merlin's management team therefore remain confident in the longer term prospects."
ROLLERCOASTER PLUNGE
Shares in Merlin fell more than 18% on Tuesday morning, sinking below 360p at one point, a level that was last familiar to investors in 2014.
Analyst Neil Wilson at ETX Capital said Merlin's reports of deterioration in international tourism over the peak trading period, "does not tally with the figures showing record inbound tourism in the UK, which may be indicative of a problem with some the older attractions it owns".
He said Merlin is now, to a degree, turning its back on Midway and focusing its capital investment on hotels.
"Investing in hotels makes sense. Enabling visitors to stay overnight at its attractions is a key part of the strategy as it boosts earnings potential, average spend, and stimulates additional demand. Merlin wants to add about 2,000 rooms by 2020. Some think this is too conservative and it could add even more rooms as it expands globally, with the resultant boost to earnings," Wilson said, believing the deal with Entertainment One to open Peppa Pig attractions globally "could be significant" and will help offset declining Midway revenues.
While investors are "right to be cautious on the outlook", Wilson pointed out that Merlin was barely a third of the way through a planned global expansion of Legoland that ought to add to considerable new revenue streams coming in the longer term "that investors who are worried about terror threats to the UK business in the near-term may want to look more closely at".
Russ Mould, investment director at AJ Bell, said took at critical look at Merlin valuation, which had risen to 21 times forward earnings for 2017.
"Never pay a premium multiple for a stock where the weather can interfere with short-term trading - because you are paying for predictability yet relying on the unpredictable," he said, but acknowledging the price premium can be justified by Merlin's strong intellectual property, powerful market positions and trading history but left the shares very exposed on the downside in the event of a sudden disappointment.
"There are few worse investments than a growth stock that doesn't grow its earnings because a loss of confidence and the derating of the stock does more damage to the share price than the profit forecast downgrades," he added.
An analysts' consensus of a 3% increase in earnings per share in 2017 and 17% in 2018 is likely to be cut, Mould said.
Steve Clayton, manager of the £250m HL Select UK Growth Shares fund, which holds a stake in Merlin, said terrorism is unfortunately becoming an increasing, additional headwind for the leisure sector, while Merlin was having individual issues with its Midway brands.
"But the group is still growing, reflecting the roll-out of new Legolands and more hotel room openings at their parks," he said, calculating that EBITDA looked set to rise about 10% on the new guidance given, with the outcome for 2018 depending a lot on the group's cost control efforts.
"The worry is that the decision to reduce investment in standing assets risks hitting attendance levels in future years. Overall, Merlin is something of a curate's egg at the moment and the group will need to work hard to keep the numbers moving in the right direction."
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