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 thePRC theme park and tourism industry (See China Consumer: A Journey JustBegun). We initiate with a Neutral rating and a DCF-driven target price ofHK$1.10 (8% potential upside) – hardly an exciting return for a little-knowncompany. Nevertheless, we think the company merits close attention – it is in theearly stages of a strategy to build out integrated theme parks across China, anda wide variety of outcomes are possible. Their first project in Qingdao looksexciting, and a strong management team has been assembled.

Our base case scenario calls for two integrated parks by 2020, reaching acombined 10.1m visitors. In a bull case scenario, if Carnival opens three parksby 2020 with 20m visitors with similar returns to Haichang (2255 HK), a valuationof HK$1.62, 59% higher than the current price, is justified. The delivery of returnscommensurate with well-run parks is essential to the investment story. If themarket reverts to simply assigning market property values to its existing projects,our adjusted NAV is HK$0.27, 74% lower than current levels. Key developmentsto watch are: 1) visitation and spending figures during summer at Rio Carnival;2) clarity on integrated park pipelines in other cities, such as Haikou.

First project fully open this summer

Next month, Carnival is scheduled to fully open its first landmark integratedleisure development in Qingdao (Rio Carnival). It will boast two hotels (738rooms), an outlet mall (~70,000 sq. m) and – the key differentiator – anintegrated amusement park – all along the coastline in the Southern part ofQingdao. As of March, it had opened 121 of 177 shops.

The Rio Carnival project will comprise three connected theme parks with familyand thrill rides, and the company aims to charge an entry fee of Rmb200 toaccess all three parks. These parks should help drive family travel demand, withproject IRR of 12%, assuming Carnival can attract one-third of the visitations tothe integrated facility. We forecast Carnival will have its on-site hotel andexhibition venue open by August 2016.

Visitation Growth is Key Earnings Driver

Carnival is still in process of moving away from its legacy property sales. Half ofFY16 sales will be from property, falling to 40% in 2017 and 36% in 2018 –completely disposing of its residential properties by 2019E. The growth willcome from retail and F&B rentals as well as admissions to the park. We forecastRio 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 toreach 4.5m in 2017E, when the facility is fully operational. We expect matureROEs 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 parkswith malls – and it will have to deliver strong visitation ramp at Rio Carnival in thenext 12 months. With investments from Wanda and other property developers intheme parks, Carnival faces tough competition to reach its visitation projections.

Carnival scores in the 4th quartile of our proprietary Macquarie Governance &Risk score, primarily due to its early stage nature.