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The cruise industry has been battered by a myriad of negative news ever since the onset of COVID-19 and the overall sentiment for the industry remains poor. However, my analysis suggests that Norwegian Cruise Lines (NCLH) is severely undervalued with risk/reward severely skewed to the upside. I believe that investors are overly apprehensive as the cruising industry has made significant progress in terms of combating COVID-19 and its disastrous effects on operations and liquidity.
On a YTD basis, the S&P 500 is up 4.4% whereas the S&P 1500 Airlines Industry and S&P 500 Casino & Gaming Industry are down 42.86% and 17.02%, respectively. On the other hand, Norwegian Cruise Lines is still down by 67.93% as uncertainty prevails for the cruising industry. However, I believe this represents an amazing opportunity for us investors to capitalize on.
Current Industry Situation
However, cruise operations in other parts of the world are already starting to resume services. In fact, the German TUI Cruises sailed in July 2020 with strict precautions and revised protocols. Additionally, two MSC Cruises will resume sailing in Europe. The MSC Grandiosa will take off on 16 August 2020 with ports including Genoa, Civitavecchia, and Naples whereas MSC Magnifica will take off on 29 August 2020, visiting the Eastern Meditteranean, Bari, Corfu, Katakolon, and Piraeus. That being said have extended their reopening dates into 2021.
For Norwegian Cruise Lines, CEO Frank Del Rio has stated in the latest earnings call that the resumption of cruising will most probably be with “a very limited number of vessels” and the company will only see the whole fleet returning in 2H21. As of today, the company has extended the suspension of cruise operations for all of their three brands: (1) Norwegian Cruise Line, (2) Oceania Cruises, and (3) Regent Seven Seas Cruises through 31 October 2020.
New Protocols to Ensure Effective Handling of COVID-19
Norwegian Cruise Line and Royal Caribbean Cruises have also joined forces to study ways on how to make cruises safer by initiating a panel called the “Healthy Sail Panel”. The two companies have brought together top experts to develop new health and safety standards. In addition, they have asked Mike Leavitt (former Secretary of US Department of Health and Human Services) and Dr Scott Gottlieb (former commissioner of US FDA) to serve as co-chairs of the group of experts.
Overall, we should expect new measures and protocols to take place when cruising. Some of these measures should include the following: (1) Social Distancing, (2) Limiting Occupancy Rates, (3) Mandatory Use of Masks, (3) Revised Dining Protocols (i.e., no more buffets or at least modified buffets), (4) Quarantine Areas for Suspected Cases, (5) Enhanced Sanitation Procedures and Air Filtration Systems, (6) COVID-19 Testing, (7) e-Muster drill.
Demand Remain Within Historical Ranges
During the latest earnings presentation, CEO Frank Del Rio stated that the booking trends continue to show that demand for the company’s position and pricing for FY2021 are well within historical ranges. This is an indication that there is pent-up demand and should be viewed with optimism as currently the company has reduced marketing efforts substantially.
It is important to note that 60% of guests on cancelled voyages have requested for a pure cash refund instead of opting for the Future Cruise Credits (i.e., awarded by Norwegian Cruise Lines to customers who had their cruise cancelled previously due to COVID-19). However, bookings for FY2021 remain well within the historical ranges. As of 2Q20, 70% to 75% of bookings are in cash whereas the remaining bookings are made using future cruise credits. In fact, 60% of all booked positions are repeat cruisers. It is safe to say that despite COVID-19, there is still a large demand for cruising.
Company’s Liquidity Ensures Survivability In a Deteriorated Revenue Environment
While demand is important for the industry. It is more important that the Norwegian Cruise Lines can survive until COVID-19 eases and/or the CDC allows the company to restart sailings. Fortunately, liquidity remains strong for Norwegian Cruise Lines. As of 2Q20, the company has taken three important steps to bolster its liquidity position.
Firstly, the company has reduced Opex and Capex significantly. The company has extended the temporary 20% pay reduction for shoreside team members through September 2020. In addition, the company will extend the furlough of about 20% of its shoreside workforce up till October 2020. In relation to Capex, the company has deferred close to US $170M for this year.
Secondly, the company has improved its debt maturity profile. In July 2020, Norwegian Cruise Lines has raised US $750M to refinance its existing US $675M short-term revolving credit facility, extending maturity from 2022 to 2026. The company has also successfully deferred US $540M of ECA-backed amortization to 31 March 2021. For FY2020, the company will not have the burden to pay down any debt obligations.
Source: Norwegian Cruise Lines 2Q20 Earnings Presentation
Finally, the company has raised additional capital substantially since March 2020. All in, the company has raised more than US $4B!
Source: Norwegian Cruise Lines 2Q20 Earnings Presentation
Based on all these efforts, the company is now well-position to withstand the effects of COVID-19. Currently, the company has 28 ships and is expected to burn US $5.7M per ship. On a group level, Norwegian Cruise Lines will have a monthly cash burn of US $160M. Based on the company’s net liquidity of US $2.5B. Norwegian Cruise Lines can weather an additional 16 months in a no revenue environment. Having trust in our technology and scientific prowesses, I believe that in 16 months, we will be free to start cruising and ships will be well prepared to effectively handle the effects of COVID-19.
Finding Value in Norwegian Cruise Lines
From a fundamental perspective, Norwegian Cruise Lines is significantly undervalued. We know that FY2020 is as good as gone but fortunately the company has raised enough liquidity to ensure survivability for the next 16 months.
Based on my analysis, we should expect revenue and earnings for FY2020 to decrease by 74% y/y and 273% y/y, respectively. Furthermore, revenue and earnings for FY2021E will not return to 2019 levels as we expect limited passenger capacity due to new regulations. As such, revenue is expected to be only around 60% of 2019 levels whereas net income is expected to be only 25% due to higher interest expenses the company has incurred as it has raised debt substantially in 2020.
However, in 2022E, we should expect revenue to reach near 2019 levels with earnings close to 80% of 2019 levels. The assumption is that capacity will be back to 90% and total operational cruises remain at 28 (vs 27 in FY2019); it is important to note that the company has the ambition to expand its total operational cruises significantly once the environment becomes more stable.
Source: Created by the author using data from Norwegian Cruise Lines
If we were to value Norwegian Cruise Lines using FY2022 earnings based on Median and Minimum PE Multiples between 2013 and 2022 we can see that the company is significantly undervalued. For reference, Norwegian Cruise Lines Median and Minimum PE multiples are 17.49x and 9.86x, respectively. Specifically, my valuation model suggests that Norwegian Cruise Lines should be worth between US $27.84 and US $43.23, representing an upside of about 125%
An Opportunity to Generate Significant Alpha
I don’t think it is wise to take up a significant exposure of Norwegian Cruise Lines in your portfolio due to the extreme volatility of its share price. However, I do believe that it is also unwise to bet against the cruising industry and especially against Norwegian Cruise Lines. After all, the company has raised enough liquidity to survive in a deteriorated revenue environment.
Based on my analysis, I believe that the upside potential far outweighs any downside risks. For investors who are willing to weather the volatility, I believe taking up a small exposure in Norwegian Cruise Lines will generate significant alpha for your portfolio, allowing you to outperform the broader market.
Disclosure: I am/we are long NCLH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.