As Chinese President Xi Jinping’s red carpet reception in the UK recently underscored, the locus of the world economy will almost undoubtedly be shifting to the Asia Pacific region in the coming years. Clever investors should be asking themselves how they can capitalise on the rising buying power of this increasingly wealthy region.
Merlin Entertainments (LSE: MERL) presents one possible opportunity to profit from the growing middle class in countries such as China and Thailand, as well as developed countries such as Japan, South Korea and Singapore.
Merlin, the operator of theme parks and attractions such as Legoland, Madame Tussaud’s and the London Eye, has one of the key competitive advantages all investors should look for in a company: a strong moat to competitors entering the field. Due to the massive costs associated with developing theme parks and the difficulty in building a well-known brand, Merlin and leader-in-class Disney enjoy significant competitive advantages over newcomers to the field. Merlin has exploited this to achieve operating margins of 25% across the company, and margins over 30% at Legoland and Midway theme parks.
The growing wealth of the Asia Pacific region hasn’t escaped the notice of Merlin’s leadership, and the company is investing heavily in expanding its footprint there. In addition to over a dozen attractions operating in seven Asian countries, the company is opening Legoland parks in Japan and Korea in the next three years, and announced during President Xi’s visit that it will be moving forward with Legoland Shanghai and new Midway-branded theme parks tailored to the Chinese market.
The expansion of Legoland parks in Asia is an astute move as Lego, the privately held Danish company, has revealed sales in Asia writ large have seen double-digit increases year on year and Chinese sales have increased 50% two years running. With the 30%+ margins Merlin extracts out of existing Legoland parks, investors should be very pleased with these planned expansions.
For fiscal year 2014 Merlin recorded 13% of group revenue coming from Asia but the company’s long-term goal is to increase this number to a third. While the stock trades at a relatively pricey 25.71 price-to-earnings ratio, the company is profitable year after year, with EBITDA of £123m on £544m of revenue in the first half of 2015, and pays a small dividend of 1.57%.
Although share prices for Merlin are down 10% from their highs in May, due to one-off hits to profits stemming from a serious roller-coaster accident at Alton Towers and subsequent lowered attendance, the stock remains expensive. With proven profitability and strong prospects in growing Asian markets, I see Merlin as a company with strong upside potential and should be watched closely as a buying opportunity if its shares suffer during a future dip in price.
