HSBC calls Merlin overvalued, cuts from 'buy' to 'reduce'

(Sharecast News) - HSBC has downgraded its rating on Merlin Entertainments, citing concerns about the leisure group's long-term growth plans.The bank cut its recommendation from 'buy' to 'reduce' and slashed its price target, from 450p to 315p. The move hit the shares hard, sending them 6% lower by 1030 BST to 352.4p.HSBC said that the short-term outlook for the owner of Legoland, Sea Life and Alton Towers was "OK".It continued: "2019 should be a year of recovery for Merlin, which has suffered badly as a result of headwinds from terrorism, FX and an accident. Even though cost pressures are building, we believe that it can growth like-for-like revenues by enough to keep EBITDA flat this year."However, the bank said that longer-term, it had more concerns, arguing that at around 8%-9%, returns on capital were "not especially compelling".It added: "New developments look set to have a different returns profile to the old ones, taking longer to mature. While they could ultimately be even more profitable in the future, this does add a greater degree of risk to the group and perhaps less transparency."The bank also argued that the returns could end up coming at the expense of growth."Our analysis suggests that like-for-like profits have been broadly flat over time, while returns from new builds have been towards the lower end of the targeted 15%-20% EBITDA range."Returns on invested capital could rise over time as the business model evolves to become more asset light, but the downside is that his could be at the expense of growth: a new Legoland development on a management contract could only add around 1%-2% to group profits, versus the more chunky increments when the group puts its own capital at risk."Unless it embarks on M&S, or finds a new format that it can roll out aggressively, that might meant that the group goes from a growth stock to one that returns excess cash to shareholders. That is not a bad thing but, again, the group is priced for more."HSBC concluded: "Ultimately, we don't see an obvious reason for it to trade at premium to UK-listed leisure groups such as Carnival and Cineworld, which also have strong growth story and make similar returns. Merlin isn't a bad business, but we do think it's overvalued."