It has been a volatile ride for investors in Merlin Entertainments (MERL) of late as terrorism concerns, business criticisms and weather issues dampened sentiment towards the company’s shares. The damage to the share price has been extensive and the company was booted out of the FTSE 100 in December 2017.

We now look at Merlin in more detail ahead of its full year results on 1 March and after activist fund ValueAct Capital took a 5.4% stake in the company, prompting speculation Merlin could be broken up.

WHAT'S HAPPENED?

One third of Merlin’s market value has been wiped off since June 2017.

Having peaked at 537p last summer, it now trades at 353.2p which is not far off the 315p price at which it joined the stock market in November 2013.

Merlin comprises three key divisions: Midway Attractions, Resort Theme Parks and Legoland. In Midway, investors will be familiar with some of the big names in its portfolio such as Madame Tussauds, London Eye and The Dungeons.

The company operates popular theme parks Alton Towers, Thorpe Park and Chessington World of Adventures, as well as family friendly destination Legoland.

Terrorism concerns have deterred many visitors, particularly over the last year. Merlin says there was an immediate drop-off in domestic visitation to London following the Westminster Bridge attack in April and demand fell further following other attacks.

Many of Merlin’s attractions are based a short journey from London or in the capital itself. Wet weather in Northern Europe, Italy and Florida also kept many visitors away over the peak summer period from some of its attractions.

In October, these negative issues came to a head, forcing Merlin to downgrade 2017 earnings expectations by 3% to between £470m and £480m as like-for-like growth slowed in the 40 weeks to 7 October to 0.3%.

ANALYST CONCERNS

The theme park operator’s underwhelming performance has brought out critics within the analyst community.

One of the detractors is Berenberg’s Owen Shirley who flagged in March 2017 that Merlin had failed to take advantage of more UK visitors, while noting Midway like-for-like growth has been on a ‘downward trajectory’ since 2010.

Hurricane Irma last year didn’t help matters by forcing Legoland Florida to close for three days and putting off visitors in the aftermath. Like-for-like growth of 3.5% at Legoland in the 40 weeks to 7 October was half the level originally forecast by Shirley at Berenberg.

‘Looking forwards, 2018 is likely to be worse, with no Lego movies to prop up elevated levels of performance and the sales of the Lego toy brand itself declining for the first time in a decade,’ commented Shirley in October.

The analyst cut his earnings forecasts following the trading update arguing the longevity of operational weakness suggests pricing and competition are additional risks.

Earnings per share (EPS) estimates were downgraded by 6% for 2017 to 20p and reduced by 10% to 20.9p the year after. Forecasts for EPS were also cut by 13% in 2019 to 22p.

MERLIN ENJOYS SOME INHERENT STRENGTHS

Despite the negative isues, it is worth remembering that Merlin benefits from strong brands and generates approximately two thirds of earnings overseas and so enjoys geographical diversification.

Approximately half of its sales are generated from Continental Europe and North America, and the remaining 14% comes from Asia Pacific.

Merlin plans to take advantage of its global reach by opening
40 Midway attractions, 2,000 rooms across its portfolio and four Legoland parks by 2020.

It is forecast to spend £700m over the next three years to generate long-term value in its highest returning divisions, Legoland and Resort Theme Parks accommodation, according to stockbroker Numis.

Pre-tax profit is anticipated to be flat at £277.5m in the year to 31 December 2017, but rise to £290.2m in 2018 and £320m in 2019 according to Reuters.

Shares in Merlin are trading at a forecast 16.1 times earnings per share for the year to 31 December 2018.

While others may view the relatively modest valuation as a reflection of challenged business, some analysts believe this represents a buying opportunity.

Numis analyst Tim Barratt anticipates Merlin will beat the bottom end of its downgraded earnings guidance when it reports full year results on 1 March.

In the US, a strong performance is expected thanks to a positive read across from Disney’s encouraging performance in its theme parks.

‘UNDERAPPRECIATED’ HOTELS GROWTH

Investors may also be overlooking value in Merlin’s plans to expand its hotel offering. Investment bank Morgan Stanley previously argued the company’s strategy to add themed hotels to its parks was ‘underappreciated’ in both profitability and scale.

In April 2017, analyst Jamie Rollo said hotels could comprise 30% of earnings if Merlin kept up its accelerated expansion and opened 7,000 rooms by 2022.

Rollo’s analysis implied the theme park operator could generate £340 revenue per room per night – three to four times higher than the market average.

‘Themed hotels provide an immersive experience for families and premium revenues to standard hotels offerings,’ commented the analyst. (LMJ)

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