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Morningstar | Norwegian Continues to Take Yield as Products Resonate With Customers; Shares Undervalued

On top of narrow-moat Royal Caribbean’s reassurance last week that the booking environment remains healthy, narrow-moat Norwegian reinforced the sentiment, noting that global demand was still rising and that both 2019 occupancy and pricing were ahead of 2018 levels across its entire portfolio of brands. As evidence, it cited a 32% increase in booking in the opening of accommodations for Seven Seas Splendor (set to launch in 2020), and 50% of the Seven Seas/Oceania deployment booked for 2019, inferring robust high-income demographic demand and elevated consumer confidence, given the willingness to book further out. With the booking environment at record levels across the industry, we understand investor concern that behavior will normalize, and the booking curve will again shorten. However, we don’t necessarily think this is negative, and as Royal recently reminded investors, the position on the booking curve is often deliberate, with the company holding back inventory in the past when it has believed that the economics of the forward year would be better.

With our prior 2018 earnings per share forecast ($4.71) within the company’s updated expected range of $4.70-$4.80 (versus $4.55-$4.70 prior), we don’t plan to materially alter our $69 fair value estimate and view Norwegian as undervalued trading at 10 times our 2019 estimate versus double-digit earnings growth over the next five years. In our opinion, of the three covered cruise operators Norwegian has the best opportunity to capture yield growth, given the contribution of new ships to the mix, and we forecast yields that rise 2.5% versus around 2% at its competitors. Further, we don’t anticipate any change to our long-term average cost growth of 1.5%, leading to industry leading EBITDA margin of more than 32% in 2022.

Norwegian put up solid second-quarter results, clocking 4.7% as-reported yield growth, versus guidance calling for 2.75% and our 2.8% estimate, thanks to better-than-expected close in and onboard performance (up 1% on an as-reported basis on 5% growth last year). The company saw organic pricing growth across its main markets boosted by an increase in capacity from both the Bliss and Joy (which entered in the second quarter of 2017) but was held back by 50 incremental dry dock days. Costs were in line with expectations rising at a high-single-digit rate, as the company paid for the higher level of dry dock days.

However, the third-quarter earnings per share is set to be modestly lower than we anticipated. While yields were generally in line with our forecast, now expected at 3.7% on an as reported basis (versus our 3.5% estimate), costs are anticipated to be higher than the flat rate we originally modeled, rising 2.75% ex-fuel, as the second half absorbs $0.10 in expenses from the redeployment of the Joy and associated sales and marketing expenses to highlight the new itineraries, along with higher compensation costs and a shift of expenses from the second to the third quarter.

Recall in mid-July Norwegian announced that it planned to move the Joy from Shanghai to Seattle in spring 2019 after investing $50 million to incorporate amended features on the ship. In turn, the Spirit (2,000 person capacity) would relocate to the region in 2020 after undertaking its own revitalization. In between Spring 2019 (when Joy leaves) and Summer 2020 (when Spirit returns), Jade is set to be reallocated to Asia-Pacific offering some stops in Hong Kong and Singapore, so the brand will have some ongoing visibility in the region. On the heels of this redeployment of assets, Norwegian expects to earn an incremental $0.30 in 2020 earnings per share and sees a modest benefit from the shuffling in 2019. Our 2020 EPS outlook of $5.81 is $0.18 ahead of consensus of $5.63 (the company doesn’t have an explicit 2020 EPS goal), and we don’t plan to materially change this estimate given the wide cyclicality of the cruise business and the duration of time between mid-2018 and the end of 2020.