HONG KONG Carnival Group An early-stage option on tourism It all depends on execution of strategy We are initiating coverage on Carnival Group as we build our coverage of the PRC theme park and tourism industry (See China Consumer: A Journey Just Begun). We initiate with a Neutral rating and a DCF-driven target price of HK$1.10 (8% potential upside) – hardly an exciting return for a little-known company. Nevertheless, we think the company merits close attention – it is in the early stages of a strategy to build out integrated theme parks across China, and a wide variety of outcomes are possible. Their first project in Qingdao looks exciting, and a strong management team has been assembled. 996 HK Neutral Our base case scenario calls for two integrated parks by 2020, reaching a combined 10.1m visitors. In a bull case scenario, if Carnival opens three parks Price (at 10:46, 24 May 2016 GMT) HK$1.02 by 2020 with 20m visitors with similar returns to Haichang (2255 HK), a valuation Valuation HK$ 1.10 of HK$1.62, 59% higher than the current price, is justified. The delivery of returns - DCF (WACC 7.3%, beta 1.0, ERP 8.0%, RFR 3.0%, TGR 3.0%) 12-month target HK$ 1.10 commensurate with well-run parks is essential to the investment story. If the Upside/Downside % +7.8 market reverts to simply assigning market property values to its existing projects, 12-month TSR % +7.8 our adjusted NAV is HK$0.27, 74% lower than current levels. Key developments Volatility Index High to watch are: 1) visitation and spending figures during summer at Rio Carnival; GICS sector Real Estate 2) clarity on integrated park pipelines in other cities, such as Haikou. Market cap HK$m 15,180 First project fully open this summer Market cap US$m 1,954 Next month, Carnival is scheduled to fully open its first landmark integrated Free float % 29 leisure development in Qingdao (Rio Carnival). It will boast two hotels (738 30-day avg turnover US$m 1.6 rooms), an outlet mall (~70,000 sq. m) and – the key differentiator – an Number shares on issue m 14,882 integrated amusement park – all along the coastline in the Southern part of Investment fundamentals Qingdao. As of March, it had opened 121 of 177 shops. Year end 31 Dec 2015A 2016E 2017E 2018E Revenue m 1,146.9 1,805.6 2,679.8 3,619.7 The Rio Carnival project will comprise three connected theme parks with family EBIT m 83.5 322.2 628.2 911.8 and thrill rides, and the company aims to charge an entry fee of Rmb200 to EBIT growth % 77.8 286.1 95.0 45.1 Reported profit m 120.5 168.1 340.3 513.5 access all three parks. These parks should help drive family travel demand, with Adjusted profit m 137.6 185.3 374.7 547.8 project IRR of 12%, assuming Carnival can attract one-third of the visitations to EPS rep ¢ 0.9 1.1 2.3 3.5 EPS rep growth % 160.4 32.5 99.5 50.9 the integrated facility. We forecast Carnival will have its on-site hotel and EPS adj ¢ 1.0 1.3 2.5 3.7 exhibition venue open by August 2016. EPS adj growth % nmf 26.8 99.7 46.2 PER rep x 117.9 89.0 44.6 29.6 Visitation Growth is Key Earnings Driver PER adj x 102.6 80.9 40.5 27.7 Total DPS ¢ 0.0 0.0 0.0 0.0 Carnival is still in process of moving away from its legacy property sales. Half of Total div yield % 0.0 0.0 0.0 0.0 FY16 sales will be from property, falling to 40% in 2017 and 36% in 2018 – ROA % 0.4 1.4 2.7 3.8 ROE % 2.8 3.5 6.8 9.2 completely disposing of its residential properties by 2019E. The growth will EV/EBITDA x 231.8 45.5 26.7 19.6 come from retail and F&B rentals as well as admissions to the park. We forecast Net debt/equity % 100.6 98.7 90.3 81.5 P/BV x 2.8 2.8 2.7 2.4 Rio Carnival will see 2.5 million visitors in 2016E. Of the new park business, approximately half of revenues are from outlet and F&B. We forecast visitation to Source: FactSet, Macquarie Research, May 2016 reach 4.5m in 2017E, when the facility is fully operational. We expect mature (all figures in HKD unless noted) ROEs of 8–10% on our base case, with OpCF positive from 2017. Key Risks Carnival’s strategy differs from that of traditional theme parks – integrating parks with malls – and it will have to deliver strong visitation ramp at Rio Carnival in the Analyst(s) next 12 months. With investments from Wanda and other property developers in Timothy Lam +852 3922 1086 [email protected] theme parks, Carnival faces tough competition to reach its visitation projections. Erin Lin Carnival scores in the 4th quartile of our proprietary Macquarie Governance & +86 21 2412 9028 [email protected] Risk score, primarily due to its early stage nature. 25 May 2016 Macquarie Governance and Risk Score (MGRS) Macquarie Capital Limited On our proprietary Governance and Risk Score Carnival Group scores in the fourth quartile of our current universe coverage. Please refer to page 20 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. Macquarie Research Carnival Group Inside New Destination in Qingdao An early-stage option on tourism 3 Company Profile Valuation and Earnings Sensitivity 6 . Carnival Group International is developing a large-scale integrated tourism Risks, Management, Corporate complex in Qingdao, Shandong Province, and is exploring similar opportunities in Taiwan and in the PRC. Governance 9 Rising Family Destinations 11 . Carnival’s project in Qingdao is one of the first large-scale integrated commercial, residential and tourism complexes, with total site area of 350,000 Integrate Leisure with Spending 12 sq. m. and GFA of 800,000 sq. m. The indoor and outdoor theme parks have Rising Demand for Leisure+ Projects 13 a total GFA of 60,000 sq. m., and the complex include two hotels for a total of Financial Analysis 15 738 rooms, managed by Langham Hospitality Group. AppendicesError! Bookmark not defined. The company has another project in Sanya and is also in talks with several Macquarie Quant View 18 provincial governments to develop new integrated leisure projects. Carnival also operates complementary leisure services such as touring carnivals (under Global Star Carnival, 78% held by Carnival), kid entertainment venue (under Haokaishi, 68% held by Carnival), and full-service buffet chain (under Golden Jaguar). Fig 1 996 HK rel HSI performance Fig 2 Qingdao Rio Carnival Project – Master Layout Plan Source: FactSet, Macquarie Research, May 2016 Source: Macquarie Research, May 2016 Fig 3 DCF Sensitivity to Visitor and Spending in Qingdao Visitors HK$ per share -50% Base Case (4.5m in 2017) +50% +100% +20% 0.87 1.17 1.48 1.78 Spending Per Head Base Case (Rmb450) 0.84 1.10 1.37 1.64 -20% 0.80 1.03 1.27 1.50 Source: Macquarie Research, May 2016 25 May 2016 2 Macquarie Research Carnival Group An early-stage option on tourism Meeting demand from family tourism Carnival is Carnival Group International (Carnival) is a developer of integrated leisure projects in China, developing family which provide an outlet shopping experience and an entertainment complex suitable for tourism product, in family visits. We believe its core strengths are in the capability to attract quality commercial an integrated tenants, and its ability to offer robust developments in entertainment units. complex that The biggest challenge in the sector is intense competition from other commercial mall combined shopping operators, and Carnival’s facilities stand out from its peers in their ability to attract non-local outlet, hotel and visitors. Its unique features such as multiple theme parks and hotel allow visitors to “stay and leisure facilities play” in this beachfront facility. This should allow the facility to attract both tour groups and self-directed travellers, and maybe able to achieve similar success in integrated developments by Shenzhen OCT in Shenzhen, China (See p. 13). As we highlighted in our China Leisure report, we see replicable and integrated projects are two models for success, such as Haichang Ocean Park (2255 HK, OP). We also like CITS (601888 CH OP) and CYTS (600138 CH) two A-share tourism plays (see China Consumer: A Journey Just Begun). Exporting Outlet + Entertainment Concepts Carnival’s project combines outlet shopping with entertainment venue for children and other family members. This concept should play well with China tourists, who tend to prefer family travel, and who are starting to appreciate the outlet model of shopping, buying branded products at discounted prices. Carnival’s facilities include children’s edutainment (e.g. Lego School, Children Career Simulation Programs) and other specialized activities that enable more time to be spent inside the integrated facility. We visited the facility and met with Carnival’s local management in October 2015, and since then we saw concrete progress. The outlet malls offer a 70–80% discount to marked prices, and the outlet shops are operated directly by the brands. The commercial area will charge tenants a percentage of their revenue. The company has engaged with The Sanderson Group to plan and design three connected theme parks.