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Morningstar | Norwegian Echoes Strong Consumer Demand Driving Rising Profitability; Shares Undervauled

Norwegian offered similarly positive commentary as its narrow-moat peers Carnival and Royal Caribbean on the demand environment, noting that the booked position for 2019 continues to exceed 2018 levels and that initially the positive cadence is carrying into 2020. Our forecast already called for yield growth of 2.5% in 2019 (as the year will be largely organic growth, with Encore arriving in November), on top of 3.6% in 2018 and 4.8% in 2017, trending to our normalized expectation of 2%-2.5% over the long term. Furthermore, we do expect costs to rise again in 2019 (to 1.2%) as the company spends on the multi-ship redeployments and the OceaniaNEXT fleet upgrades (at the cost of $100 million), which are both efforts that stand to bolster Norwegian’s brand intangible asset, a factor underlying our narrow economic moat.

We don’t plan any material change to our $69 fair value estimate and see multiple opportunities for Norwegian to grow profitability ahead. In the near term, the redeployment of multiple ships announced earlier this year (including the Joy out of China) could prove more lucrative than the original $0.30 benefit originally anticipated, as Alaska has remained a banner market for the Bliss. Additionally, if fuel costs decline, they could materially assist 2019 cost metrics, particularly as the company attempts to hedge more tactically with gasoil contracts. Admittedly, higher near-term costs with incremental dry dock and fleet optimization costs could offset some of these gains. With shares trading at around a 27% discount to our fair value estimate and below 10 times next year’s earnings per share estimate, we view shares as attractive, particularly given our expectation for low-double-digit EPS growth over the next five years.

Norwegian’s third quarter offered better-than-anticipated yield and cost results than we originally forecast. As-reported net revenue yields rose 3.9%, above both our estimate and company guidance calling for a 3.5% increase, as close in bookings and onboard spend remained healthy. Both ticket and onboard increased 4%, indicating that the price component of yield is strong, carried by the solid brand resonance with the company’s consumer base, in our opinion. Strength in pricing appears to be carrying into the final quarter of 2018, with as-reported yield growth of 3.75% anticipated, ahead of the 3.6% our model had included. Net cruise costs excluding fuel rose 2.1%, better than the 2.75% Norwegian had anticipated as certain expenses were shifted into the final quarter of the year.

Despite the expectation of single-digit EPS growth in 2019, with no new hardware entering the fleet until November, we still think Norwegian is positioned to deliver on its three-year goals (through 2020) that include double-digit EPS growth, ROICs around 12%, and rising free cash flow (with cash available to return to shareholders of $1 billion-$1.5 billion). Our three-year forecast calls for 14% average EPS growth, ROICs of 11.9%, and free cash flow of $1.7 billion over the 2018-20 period. We think these financial metrics could lead the board to warm up to initiating the firm’s inaugural dividend, which we anticipate could occur as early as 2019.