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Morningstar | Slower Yield Growth Drags on Carnival’s 2019 Outlook; Shares Attractive

More tepid than expected price growth in 2019 weighed on Carnival's share performance post-fourth-quarter profit results, with 2019 constant currency yield growth forecast for just 1%, a significant slowdown from the 4% the company was able to capture in 2018, but also a tick down from the implied first-half guidance the company's commentary offered last quarter (lower than the 1.5%-2.5% originally forecast for the fourth quarter). While technically 1% constant currency growth is lower than 1.5%-2.5%, we surmise that most investors expected that the first half would post near the bottom of the range but anticipated the second half would be stronger, inferring a full-year lift from the level, which has failed to surface. More disconcerting is whether the failure to capture meaningful yield growth is predictive of a lower consumer willingness to spend in the category, something we don’t believe we will have a clear picture on until mid-2019. For now, all measures point to spending remaining healthy for the domestic consumer, which represent around half of Carnival’s sourced customers.

Mitigating yield downside is better than we originally anticipated cost (excluding fuel) improvement in 2019, which Carnival forecasts to rise just 0.5% on a constant currency and fall 1% on an as-reported basis, well below our forecast for an as-reported 0.5% cost ex-fuel increase. With lower yield and lower costs incorporated ahead, our 2019 earnings per share estimate of $4.57 should remain largely unchanged and falls squarely into the company’s outlook for EPS of $4.50-$4.80. We do plan to lower our $69 fair value estimate by a few dollars to adjust for higher capital expenditure guidance offered that reflects the true spending outlook for the company ahead. That said, we view shares as undervalued trading at less than 11 times the midpoint of updated EPS guidance and at a more than 20% discount to our updated fair value expectation.

The 2019 outlook doesn’t alter our longer-term outlook that calls for below 2% as-reported yield and more than 1% cost growth. This is modestly better than the 1% average as-reported yield growth and modestly worse than the 1% cost growth the company has captured post-recession (2009 and beyond). The silver lining for Carnival is that despite slower yield growth, operating cash flow should still rise ahead, supporting debt service, dividends, and increasing share repurchases (particularly since the shares have tumbled from 52-week highs of $73). With the least leveraged balance sheet of the three sizable publicly traded cruise operators, we think Carnival will likely trade more narrowly than its peers (narrow-moat Norwegian and Royal Caribbean) in the event of an economic downturn ahead, attracting more conservative investors seeking entry into share ownership in the category.