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Morningstar | Norwegian's Yields Rise Faster Than Costs in 1Q, Leading to Full-Year EPS Lift; Shares Undervalued

Narrow-moat Norwegian Cruise Line's first-quarter adjusted earnings per share result of $0.83 outpaced our estimate by about $0.15, with as-reported yield growth of 3.2% pacing 100 basis points ahead of our outlook and net cruise costs excluding fuel higher than we anticipated at 2.9%, also about 100 basis points higher than our estimate (the company forecast included 2% growth for yields and costs ex-fuel on an as-reported basis). This shouldn’t significantly change our 2019 outlook, however, which already called for yield growth of 3.3% and cost growth ex-fuel of 2.8% on an as-reported basis, in line with the company’s updated forecast for yields of 3%-4% (up from 2.5%-3.5% prior) and costs ex-fuel of 3% (2.75% prior). We don’t plan any material change to our $69 fair value estimate and view the shares as undervalued, trading at 10.5 times the midpoint of updated 2019 EPS guidance versus a low-double-digit EPS growth rate in our forecast.

In our opinion, Norwegian has disproportionately benefited in recent periods from its higher-than-peer-group exposure to the North American sourcing market, with 77% of 2018 sales from U.S.-sourced customers, which anecdotally (from first-quarter commentary across Carnival, Royal, and Norwegian) has been the strongest demand geography for cruising. In turn, this has exposed Norwegian to lower foreign exchange risk, with just $0.10 per share in incremental fuel and foreign exchange headwinds since the last update. Furthermore, Norwegian continues to actively shift deployments to capture yield lift, noting that Joy (which just moved from China to Seattle for summer 2019) is moving to New York and Encore is heading to Seattle over the next year. This supports our solid yield growth forecast, which averages about 2.5% over the next decade (moderating from the 4% the company achieved over the last decade, which includes the Prestige acquisition) and leads to EBITDA margin performance of 34%, up from 32% in 2018.

There were numerous data points offered supporting the positive momentum the Norwegian brands have already garnered. First, the fleet continues to be booked at similar (record) loads and higher prices to last year, implying that Norwegian can continue to capture yield increases. Second, Oceania and Regent are already 40% sold for 2020, meeting this mark earlier than in the past and at higher prices, conveying that consumers have confidence to book more than 6-12 months out. Third, advance ticket sales for the fleet were 18% higher at the end of the first quarter than the same period last year, despite a less than 3% increase in capacity for the firm in 2019, indicating that the company could be taking share of the vacation market as the value proposition resonates with customers. And finally, while the competitive set has articulated some instability in the U.K. and European region, Norwegian has captured a double-digit increase in booking volume since it transitioned to Free at Sea from Premium All Inclusive just five weeks ago. These tailwinds should provide significant free cash flow (averaging more than $900 million over the next five years in our model), supporting the return of capital to shareholder via share repurchases (with $200 million bought back in the first quarter) and the potential initiation of a dividend, which we model to start later in 2019.