Norwegian Cruise Line – Tempting Growth and Value

Overview

Norwegian changed the dining structure in cruises and established freestyle format, where passengers can do what they want, when they want. Many companies now pursue that format. Norwegian’s ships also provide more than food. Passengers are able to join theater performances and race go-carts on the vessel’s track. Also, active casinos and bars offer alternatives for young people. However, in recent earnings call, one investor asked a question about the demographics of customers and Frank Del Rio answered that majority of customers are baby boomers and millennial demographic group is still growing. He thinks that the demographics will be changing anytime soon given the longer itineraries that those brands operate in at the much higher prices that they operate.

Establishing a competitive advantage in traditional cruising is considerably hard due to less pronounced differences. However, with the addition of Prestige’s brands and different routes provide developing brand awareness and scaling of economies costs.

The company offers diverse itineraries from China to Australia, Africa and west-side of the United States. Norwegian’s aim of new markets and developing visiting experience and optimizing capacity contribute product differentiations relative to its peers. Also, it has a luxury segment of Prestige, which meets the expectations of upper-class individuals. The competitive and price sensitive industry of cruise business create steep discounts and similar cruise experiences. However, Norwegian’s differentiated products and luxury brands offer opportunities to the company.

In recent earnings call, Frank Del Rio, CEO and president, answered that majority of customers are baby boomers and millennial demographic group is still growing. Establishing a competitive advantage in traditional cruising is considerably hard due to less pronounced differences. However, Norwegian’s differentiated products and luxury brands offer opportunities to the company.

Investment Characteristics

Norwegian has accelerating revenue growth, with a 10-year average of 9.52% per year. NCLH’s revenue is seasonal and based on the demand for cruises. The company recognizes revenue in an amount that corresponds directly with the value to the customer of its performance completed to date. As of September 30, 2018, the company’s contract liabilities were USD 1.3 billion. According to the company’s cancellation policies, Norwegian’s approximately 50% of contract liabilities are refundable. The company’s SEC filing also states that Norwegian’s deferred revenue is increasing as a result of increased number of reservations preceding seasonally peak demand periods.

The company’s majority of transactions are settled in USD. However, the company had foreign currency exchange rates exposure related to its ship construction contracts in euros. Norwegian uses foreign currency derivatives to partially hedge the exchange rate risk on a portion of the payments on its ship construction contracts. The payments not hedge aggregate USD 2.7 billion based on EUR/USD exchange rate as of September 30, 2018. The company estimated that 10% change in the euro as of September 30, 2018, would result in USD 0.3 billion change in the USD value of foreign currency denominated remaining payments. Norwegian’s 73% of its debt was fixed and 27% was variable, which includes the effects of the interest rate swap as of September 30, 2018.

Norwegian’s operating margin increased from 15% to more than 20% as improved pricing, more luxury ships, and acquisition of Prestige as of September 30, 2018, in the past five years. However, we predict that pricing growth may depress the operating margin relative to prior periods. Increased supply and stable demand could invert the yield curve but, premium new ships may help to flatten the revenue increase percentage.  The company may reverse the steady long-term yield growth with succeeding lower-yielding itineraries with new and premium routes.

Norwegian’s deferred revenue is increasing as a result of increased number of reservations preceding seasonally peak demand periods. We predict that pricing growth may depress the operating margin relative to prior periods. Increased supply and stable demand could invert the yield curve but, premium new ships may help to flatten the revenue increase percentage.

Valuation

Our fair value estimate for Norwegian is USD 63 per share. We classified the company’s industry as consumer cyclical due to seasonal revenue changes. After considering a market share in the cruise industry, we categorize the company as mid-cap and core investment. We estimate the company’s enterprise-value-to-EBIT ratio of 19.82. Also, an estimated enterprise-value-to-sales ratio is 3.80 in our analysis. For strengthening its liquidity through more favorable rates and the extension of maturities, Norwegian announced the refinancing of its senior credits and stretching the maturity dates of these credits to January 2024 as of January 2, 2019. We assess Norwegian’s advantageous reservation demands with high occupancy rates in 2019 and increased pricing comparing to last year in all three segments. In order to support the demand levels, the company’s CEO mentioned a 25%-plus pricing increase on the Norwegian brand’s three-ship Alaska deployment, despite a 15% capacity increase, a second consecutive year of double-digit pricing growth for the all-important Europe season, and 2019 book position remains well ahead of this year’s record levels in occupancy and pricing across all three brands with advance ticket sales up 24% year-over-year on an 8% increase in capacity. Recent price increases and beneficial demand supports our short-term growth rate. However, we also considered cost increases due to rapidly changing consumer tastes and luxury segment focus. In the long-term perspective, we forecast revenue and operating expenses to rise by approximately 2.5%-3.5% range. The company’s increased capacity, improved brand recognition, new premium ships may create sustainable EBITDA margins in short-term.

Risks to consider

Norwegian’s major risks are commodity price fluctuations, geopolitical tensions on routes, consumer spending habits, similar to its competitors. The company broadens its fleet with receiving flexible financing. We determined that a low-interest rate environment is viable to continue to grab premium segment consumers. Norwegian ordered two vessels from Fincantieri S.p.A for delivery in 2022 and 2025 as of January 8, 2019. The contract is approximately EUR 1.15 billion with export credit financing to fund 80% of contract price. The recent contract supports Norwegian’s reasonable financing efforts. Also, the company’s board has a member and voting rights for Apollo Holders. Shareholders of Apollo and Genting HK are selling their shares as part of an ongoing stock buyback program. We think that these two shareholders may strive to influence the board even though their declining ownership at the expense of remaining shareholders.

The entrance of competitors is limited, and the market share of current vessel operators dominate the industry. The construction of ships and finding qualified dockyards require long-waiting times, which prevent excessive competition. Also, the cost of each vessel also needs extensive liquidity and steep capital.

The entrance of competitors is limited, and the market share of current vessel operators dominate the industry. Norwegian’s major risks are commodity price fluctuations, geopolitical tensions on routes, consumer spending habits, similar to its competitors.

Other considerations

Norwegian has two board members over ten years of company experience, and remaining seven members have approximately three years of average tenure. The board has three subdivisions, with each class having a three-year term. The structure of the board is in line with its policy and shareholder protection of excessive board rotation is intact.

The company’s president and CEO, Frank Del Rio, has worked with Norwegian since 2015. He served as CEO of Prestige, which was acquired in 2014. The president’s total compensation was more than USD 10 million in 2017. The increase in his compensation was more than USD 7.5 million compared to 2016. According to the company’s filing, Mr. Del Rio’s son was Senior VP of Port, Destinations and his brother was Senior Director of Hotel Procurement as of April 2018. Investors may carefully consider prospective nepotism and conflict of interest risks.

Conclusion

NCLH Stock Movements 012019
Source: tradingview.com

The company’s price-to-earnings ratio is at the lowest levels due to recent price decreases. Norwegian’s steady market share in the cruise industry, relatively new vessels, and more luxury segment focus may provide pronounced growth opportunities. Investors also need to consider interest rate risk of Norwegian’s debt instruments, foreign currency exchange risk related to its construction contracts.

Disclosure: I do not have any of the securities mentioned above. This article expresses my own views, and I wrote the article by myself. I am not receiving compensation for it. I have no business relationship with any company whose security is mentioned in this article.

Image Source: Mergr website

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Covers investment, financial analysis and related financial market issues for BrightHedge. He has extensive experience in portfolio management, business consulting, risk management, and accounting areas.

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The investment information, comments and recommendations contained herein are not subject to investment advice. The comments and recommendations contained herein are based on personal views. These views may not fit your financial situation and your risk and return preferences. For this reason, based only on the information contained herein, investment decisions may not have the appropriate outcome.