EUR 850.00 For Business Accounts Only

Morningstar | Organic-Growth Year Sets Norwegian Up for Steady Profit Increase in 2019; Shares Undervalued

We don’t plan any material change to our $69 fair value estimate for narrow-moat Norwegian Cruise Line and view the shares as undervalued, trading at about 10.5 times the midpoint of updated earnings per share guidance of $5.20-$5.30. With a mostly organic year ahead (Encore doesn’t enter the fleet until the fourth quarter), the company’s initial take on 2019 wasn’t much different than our forecast. Our net yield forecast of 2.5% was at the low end of Norwegian's 2.5%-3.5% as-reported yield outlook, and our net cruise cost projection of 2.4% growth was just modestly below the 2.75% as-reported expectation from the company. With a modestly wider adjustment upward in our yields than costs in 2019, our updated EPS forecast should rise from $5.14 into the guidance range, creating little impact to our intrinsic value.

Norwegian has done a stellar job of improving its balance sheet, taking leverage from nearly 5 times after the Prestige acquisition (2015) to 3.3 times in 2018, and we expect net debt/EBITDA to decline to around 2.6 times in 2020, putting Norwegian squarely into investment-grade territory. More important, balance sheet flexibility provides the company with the ability to return excess cash to shareholders. With $600 million left on its $1 billion repurchase authorization, reaching double-digit EPS growth should be feasible over 2018-20; however, most of the remaining growth will be concentrated in 2020, when Norwegian benefits from nearly a full year of Encore and the launch of Regent Seven Seas’ Splendor in the fleet. Given rising free cash flow metrics, we think a dividend could be initiated as early as 2019, potentially attracting a new investor base.

Norwegian wrapped up its final 2018 quarter with solid 4.2% as-reported yield growth, helped by healthy close-in bookings and onboard revenue; even without the addition of new hardware (Bliss), the fourth-quarter yield would have nudged down only slightly. However, on the cost side, expenses per diem excluding fuel increased 3.4% on an as-reported basis, with higher prices offset modestly by fuel savings efficiencies. With a solid 2018 in the rearview mirror, we were relieved to hear that numerous past positive demand contributors appear intact and could further bolster financial growth ahead. Most important, all three brands are booked at higher prices and occupancy levels than at the same time last year, with the booking curve expanding 9% from elevated lengths last year. High-end brands Oceania and Regent Seven Seas are 80% booked for 2019 and around one-third booked for 2020, implying that consumers feel positive enough about their economic position to secure travel opportunities further out. Moreover, for the Norwegian brand, earlier bookings indicate additional time between the booking and the sail date, allowing for the replenishment of wallets, supporting incremental onboard spending.

However, 2019 (and 2021) are likely to see modest, single-digit earnings per share growth as years with minimal new hardware benefit. Norwegian outlined factors set to waylay historical EPS growth rates in 2019, which include slower capacity growth (2.7%), the lapping of robust earnings (24%) and yield (3.7%) growth, higher marketing costs affiliated with new ship launches (Encore, Splendor), and itinerary optimization efforts (Joy, primarily). We think these factors set Norwegian up for improved profitability ahead, with ships reallocated to appropriate locations generating higher EBITDA margins, driven by the brand equity the company has already built with a rising consumer base (a key tenet underlying our narrow moat rating).