The Theme Park Empire:
Founded in 1998 Merlin has grown into a £3.5bn pound company. In the last decade the group has enjoyed growth of circa 7% per annum while the future holds strong expected growth through 2019 and beyond. The group delivered £323m operating profit, breaking down to £209m net profit post tax and other relevant deductibles for 2017.
The Merlin group is famous for its Legoland resorts, Madame Tussauds and its Alton Towers theme parks. By most measures it is the second largest leisure group globally, behind front runner Disney.
The Business Model:
In the past Merlin have held substantial property holdings, but offloaded circa £1bn pounds of property assets during the merger with Tussauds in 2007. Today they are geared less towards property and more towards the leisure industry, while utilising long-term leasebacks. This de-risks exposure to the property markets, while freeing up capital and liquidity that would otherwise have been needed to purchase expensive properties.
This freed up capital was used in 2007 to provide liquidity, and today it is used to fuel growth. Core investments into both Miday and Themeparks is set to grow at 7% per annum through 2019 and beyond.
Another cornerstone of growth for the group is its diversification into providing accommodation onsite at its attractions. This has so far proven lucrative with double digit margins and lack of any substantive cannibalisation of its current offerings.
The Macro Environment:
Travel and tourism growth was 4.6% according to the World Travel and Tourism Council with continued growth through 2018, 2019 and into the 2020s.
Similarly, the market analysis research report on the Global Leisure Travel Market reports similar growth expectations through 2018-2025 as consumers experience continued wage growth leading to higher disposable incomes.
There is a general consensus among analysts that the leisure industry will see strong growth in the next 3-5 years. This growth should lead to slightly higher margins and profitability for the wider industry with the caveat of current global leisure capex expenditure being maintained at current levels. Overall, this is a highly promising picture.
The Good of Merlin Entertainment
Leisure Industry Growth:
The Leisure sector is experiencing rapid global growth, specifically in Asia where Merlin is currently in talks with stakeholders to open multiple major new attractions. There are further plans to test the two new brands, Peppa Pig and Bear Grylls Adventures in Asia and globally in search of the next milestone in highly profitable attractions.
Hotel & Accommodation Services:
In recent years Merlin have started investing in on-site accommodation at its largest and most popular resorts, such as Legoland. The margins on this business are in the mid to high 20s providing an attractive proposition for future investment. Expansion of accommodation services will continue through 2019 and beyond, with initial analysis showing little cannibalisation of other product offerings through providing this additional set of services.
The Lego Movie 2:
The precedent set by the first Lego movie has led the markets to have high hopes for Lego 2 which is released during Q1 of 2019. The first movie provided a meaningful impact on like for like visitor numbers, with the movie attributing a 6.6% increase, with revenues rising a similar amount.
Coupled with higher 2019 capex and new attractions, a repeat performance of the 2014 runaway success during 2019 would allow Merlin to have excellent performance through the year ahead.
Two New Brands:
In search of the golden goose Merlin continues to develop experimental concepts that could one day become the next runaway success. Through 2019 two new brands, Bear Grylls Adventures and Peppa Pig World of Play will be launched.
The primary difference between the two new brands would be the capital expenditure (capex) required to launch at a new site. Bear Grylls Adventures is expected to have capex of circa £25m per site whereas Peppa Pigs capex is significantly lower, at around £5m per site. Analysts will be closely watching the performance of these brands through 2019.
2019 Growth Prospects:
Plans have been set in motion to add 10 to 12 new midway openings in 2019, and this brings Merlin back on track with growth after relative stagnation in 2018.
International Focus: Currency Implications:
Headwinds from Brexit negotiations are continuing to fuel volatility in sterling which is leading to a degree of uncertainty for Merlins international profitability through late 2018 and beyond. Merlin has benefited in 2018 from a weakening of the pound, increasing its profitability in international markets.
Domestically, there has been an increase in visitors and tourism since the Brexit referendum. The consensus by analysts is that this is primarily down to weakness in sterling, making it comparatively cheaper for international holiday makers to visit Britain.
Dependant on the negotiations of Brexit will be the future rise or fall in sterling: a deal that allows the UK to stay relatively close to the EU would be a major enabler of sterling strength through 2018. Whereas a so called “hard-Brexit” where the UK is further apart from the EU would lead to further weakness in the value of sterling.
To dig a little deeper at where Merlin generates its revenues, here is the breakdown of sales by geographic markets at the end of 2017:
The Bad of Merlin Entertainment:
Higher Capex in 2019 and Beyond:
With growth set on the higher side of 7% through 2019 capital expenditure is expected to grow to levels seen in 2017. This increase will in part be offset through the use of financing partners such as investors and governments.
There are on-going talks between Merlin and the South Korean government for the funding of a new major South Korean attraction on which analysts are awaiting the result.
In addition to this, there has been recent reassurances from CEO Nick Varney that the 2020 New York Legoland is on track to open in 2020.
Higher Labour Cost Pressures:
As the world has recovered from the 2009 financial crisis employment has risen to record highs across much of the developed world. This effect is especially pronounced in its UK market, with wage growth finally starting to bite opex (operational expenditure) at many of Merlins attractions.
Higher Opex Growth:
Analysts expect opex growth above the current run rate of 2%-3%. There is no consensus yet on the proposed plans for productivity increases to offset the increased burden of labour cost pressures on the group. That said, there is a quiet sense of optimism that this approach will offset at least part of the wage pressures mentioned above.
Individual Park Execution Issues:
There have been suggestions from the Merlin management that have stated issues at particular attractions due to execution at the park operation level. This is perhaps caused by the relatively large scope and discretion that individual park managements have control over in relation to the park they run and manage. While this is often a strength that allows innovation and improves the quality of service provided, it can just as easily end up as a costly mistake, and this highlights the inherent weakness of this delegation.
This report will now look at a few key indicators of financial performance, but should not from as the complete (as it is far from it) basis of financial research. This is due to its limited scope in not including various important models and calculations, such as financial ratios and other issues we mention under “Further Financial Analysis”.
We will be using the following sources for our data:
1. Introduction to Merlin presentation from November 1st 2018
2. Trading Update from October 16th 2018
3. Annual Report & Accounts for 2017 released on March 23rd 2018
All these reports can be found on Merlins results page.
The headline figures from the annual report for 2017 include the following:
|Post Tax Profit||£209m|
|Free Cashflow (Nov 18)||£315m|
|Total Net Assets||£1,567m|
The first measure we will look at is profitability in relation to sales, which would be calculated as 209 / 1,594 * 100 = 13.1% profitability margins. This is perhaps on the lower side of expectations but this should increase slightly through 2018 as environmental factors remain favourable. This type of profitability margin is an indicator of management performance when benchmarked against competitors, which while outside the scope of this report would be worth perusing.
Overall levels of debt are not unduly concerning, and gearing ratios could be calculated to help formalise this. The results would indicate a moderate ability to raise capital at relatively reasonable rates, but there is no current plans by management to expand self-funded new attractions outside of the US and UK. Both markets of which the group understands well and where Merlin believes it could create acceptable returns on capital deployed.
The management have reiterated its commitment to dividends of between 35% and 40% of profits. This breaks down to 7.5 pence per share or 2.24% for 2018, up slightly from 2017 figures.
Merlin Entertainment is a leisure industry powerhouse, it has strong fundamentals and exciting projected growth over the next 3-5 years. It trades at a relatively high valuation that reflects its strong position and optimistic environment moving forward. For these reasons it is in no way a bargain at current prices, but strong growth over the coming 24 months has potential to see the stock move considerably higher. Current Horizon Rating as of December 2018: Hold.