Can Merlin bounce back from 20% slump?

Another day, another profits warning on the FTSE 100 (UKX). It’s the third trading day running there’s been a 20% plunge within the UK’s blue-chip index, following yesterday’s travails at medical product supplier ConvaTec (CTEC).

Today, it’s the turn of Merlin Entertainments (MERL). The theme park operator saw shares plunge to a three-year low 370p Tuesday, after it said full-year cash profit will now be in a range of £470-480 million, rather than the £489 million previously expected.

It cites two reasons for the fall in expected profit. Poor weather in Europe and the US and recent terrorist attacks deterred people from visiting its attractions, we’re told.

While favourable exchange rates boosted total revenue growth to 12.4% year-to-date, like-for-like growth stalled. It’s currently flat on 2016, despite 3.4% growth from its LEGOLAND parks.

LEGOLAND’s revenue boost was offset by a LFL revenue declines of 1% in Midway Attractions – think Madame Tussauds and London Eye – and 2.1% in Resort Theme Parks, incorporating Alton Towers, Chessington World of Adventures, Thorpe Park and others.

We’ve noted previously that share prices tend to move on short-term noise, so the slump in the stock on today’s profits warning is no surprise. However, Guy Ellison, head of UK equities at Investec Wealth & Investment, argues the long-term potential of Merlin’s brands is “very significant”.

Merlin has added to its existing portfolio by signing a deal with Entertainment One to leverage the Peppa Pig brand. It’s also planning to open a Bear Grylls attraction in Birmingham next year. That will be followed by LEGOLAND New York in 2020.

Merlin’s now reducing investments in its existing estate by £100 million over the next three years, and reallocating capital into bolstering its on-site themed accommodation portfolio and increasing its focus on cost efficiency and productivity improvements.

It’s not the first time Merlin has suffered “temporary demand shocks”: Numis analyst Tim Barrett notes these have previously presented buying opportunities.

Ellison notes that “better weather in 2018 and the absence of any further terrorist activity in key city centres would make for some easier comparables” this time next year. While this is true, they are factors outside of management’s control.

Merlin is instead banking on the addition of Peppa Pig and Bear Grylls, as well as its decision to reallocate capital, to improve things in the longer term. But the latter brings increased risk in the short term.

Still, Peel Hunt’s Ivor Jones reckons the share price fall is yet another “buying opportunity for investors”, reiterating his 530p target price.

While not ideal, Panmure Gordon’s Mark Irvine-Fortescue says a 3% downgrade in EBITDA is not disastrous. “We would regard a sharp share price reduction as a good entry point to one of the highest-quality portfolios in the sector,” he says.

Don’t forget, shares had been strong early October on rumours Merlin was interested in taking over parts of US theme park giant Seaworld. While Seaworld’s not on the agenda now, Deutsche Bank reckons there’s plenty of scope for M&A activity given the strength of the cash flow and balance sheet.

Chief executive Nick Varney says there’s “still plenty more magic to come”. There certainly is for visitors; investors will be hoping that’s the case for the share price, too.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.