Three cruise operators with the wind at their backs

These companies have multiple trends working in their favour, and they are trading at attractive discounts.

Vikram Barhat 30 May, 2018 | 5:00PM
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As the summer months approach, families and individual vacationers are furiously planning their next getaway for a much-needed break from the daily grind. A record number of these people, both first timers and seasoned seafarers, are expected to go on a cruise holiday, as per the Cruise Lines International Association (CLIA). It's little surprise that the outlook for the global cruise industry is brighter than ever before.

Long considered a happy hunting ground for North American retirees, the cruise liners today are carrying a highly diverse clientele from a much wider geographic footprint, including a rocketing number of Asian middle-class and millennial holidaymakers. With passengers from China alone far exceeding 2 million, making it the second-largest market after the U.S., the cruise industry clocked more than 26 million people who took cruises in 2017, and is projected to surpass 28 million in 2018, according to the CLIA report.

As more consumers choose the thrill of experiences over the gratification of material acquisitions, they are happy to splurge on memorable vacations. The trend conspires with favourable economic conditions and greater interest in ocean cruising, which has jumped more than 20% over the last five years, to create a tailwind for the industry, says the CLIA report.

While their growth prospects are undeniable, individual cruise operators are currently trading far below their January peaks, reflecting an attractive discount to their fair values. For long-term investors, it's hard to overlook the upside potential and profitability of leading operators that control 90% of the market. With a swelling armada of luxury vessels, they are aggressively expanding, innovating and customizing their itineraries and deck-top action to tap burgeoning but relatively under-penetrated markets of the world.

Carnival Corp.
Ticker: CCL
Current yield: 2.80%
Forward P/E: 14.3
Price: US$64.25
Fair value: US$70
Value: 8.2% discount
Data as of May 28, 2018

 Carnival (CCL), the largest company in the cruise industry, operates 10 global brands with more than 100 ships in service and passenger capacity of more than 200,000. The company caters to more than 12 million guests annually -- a diverse group of consumers in a lightly penetrated vacation segment.

Its global reach and tailored fleet position it well to capitalize on underserved international markets. "Carnival's market is underpenetrated, with less than 4% of the domestic market ever having cruised," says a Morningstar equity report. "With low domestic penetration, and even lower international recognition, upside potential remains significant."

Carnival's increased focus on faster-growing and underrepresented regions like Asia-Pacific could help offset saturation in high-capacity regions like the Caribbean, and facilitate more lucrative pricing strategies globally. The nascent Asia-Pacific market represents a significant long-term growth opportunity, with China alone accounting for 2.8 million cruise passengers last year.

Much of the domestic business, though, is driven by retirees. "The aging population will drive demand and create a disconnect between the demand in the market and the supply of berths for at least the next 10 years as the 65-and-older demographic grows faster than overall cruise industry capacity," says Morningstar equity analyst Jaime Katz.

Responding to demand growth, Carnival plans to add 18 new cruise ships to its fleet by 2023, of which four are due to set sail this year.

Katz recently upped the stock's fair value, prompted by cash earnings, from US$67 to US$70, implying a 2018 P/E ratio of 16 times. She projects Carnival's EBITDA (earnings before interest, taxes, depreciation and amortization) margins and returns on invested capital to rise steadily to 31% and 13%, respectively, by 2022.

Norwegian Cruise Line Holdings Ltd.
Ticker: NCLH
Current yield: -
Forward P/E: 11.5
Price: US$54.13
Fair value: US$69
Value: 21.6% discount
Data as of May 28, 2018

The world's third-largest cruise company by berths,  Norwegian Cruise Line (NCLH) operates 26 ships across three brands, offering both freestyle and luxury cruising. With six passenger vessels on order through 2025, the company is boosting capacity faster than its peers, expanding globally.

"Norwegian's capacity has risen to more than 50,000 berths from around 30,000 prior to the acquisition of [the high-end] Prestige Cruises, making it an increasingly relevant competitor," says a Morningstar report, pointing to the firm's ability to "nimbly cater to changing trends [by] capitalizing on decades of consumer analytics and best practices."

The acquisition of Prestige creates a buffer against choppy economic conditions since the brand targets wealthy consumers who tend to enjoy relative insularity from economic uncertainty and price hikes.

The cruise line is also making a renewed push into the Asia-Pacific market, returning to it last year after a gap of 15 years. "With a heavy weighting to Caribbean cruising, expansion into markets like Asia and South America creates a tremendous growth opportunity for the business," says Katz, who appraised the stock's worth at US$69.

Closer to home, the company recently rolled out one of its biggest ships, Norwegian Bliss, with resort-like facilities and top-flight entertainment features to compete with rivals in Alaskan waters. The brand is expected to have 17 ships in operation by the end of 2020, says Katz, adding that the company "remains in an enviable booked position, with load and pricing well ahead of last year for the rest of 2018 and for the early 2019 bookings."

Norwegian recently reported a 67% jump in first-quarter profit and a 12.4% year-over-year revenue increase, and announced a US$1 billion three-year stock repurchase program.

Royal Caribbean Cruises Ltd.
Ticker: RCL
Current yield: 2.08%
Forward P/E: 12.3
Price: US$109.80
Fair value: US$132
Value: 16.8% discount
Data as of May 28, 2018

The second-largest company of the oligopoly,  Royal Caribbean (RCL) operates more than 50 ships across six brands including Royal Caribbean International and Celebrity Cruises. The company, which recently added a 25th ship to its fleet -- Symphony of the Seas, claimed to be the largest cruise ship in the world -- also has a 50% stake in a joint venture that operates Germany's TUI Cruises and a 49% stake in the Spanish cruise line Pullmantur.

"Royal Caribbean's brands continue to drive repeat business, as the innovation and quality of its vacation products remain topnotch while offering a compelling value proposition to travellers," says a Morningstar equity report, noting that its continued focus on pricing integrity (not offering last-minute discounts) could help preserve brand strength and support ticket price increases over time, whereas differentiated onboard offerings could spur incremental revenue growth.

Royal's target audience remains relatively underpenetrated both at home and away. Domestically, the baby boomer demographic will continue to drive demand as more of them retire and have more leisure time. Internationally, Asia and Europe could provide more significant demand potential. "High satisfaction rates and percentage of repeat clients implies that reaching deeper into these underserved population bases is imperative for Royal's growth over the long term," says Katz, who pegs the stock's worth at US$132, and projects EBITDA margins to expand from 31% in 2017 to more than 33% over the next decade, provided the company maintains its premium brand image while stringently crimping costs.

After a rollicking start to 2018 with a first-quarter net income of US$232.8 million, up from US$214.7 million the previous year, CEO Richard Fain increased the full-year guidance and announced a US$1 billion two-year share repurchase program.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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