CCL’s valuation looks reasonable based on Street 2009 estimates of $2.15, in line with management guidance of $2.10-2.30. Moreover, the Street estimates look doable, although they should probably be reduced with the recent spike in fuel costs and FX moves. At current spot rates, fuel costs will be about 5% higher in Q2 than management’s guidance and 9% higher in 2H 2009. Nonetheless, EPS estimates are probably in the ball park.
It is 2010 where we differ materially. Our $1.33 estimate is 40% below the Street. Analysts are currently projecting flat to slightly down yields for 2010. I’d like to speak to their economists that are projecting such growth in consumer spending to offset the 9% industry capacity growth slated for 2010. Even in a big 2010 rebound scenario, demand probably won’t grow more than 3-5% which still implies down 4-6% yields. That seems to be a best case scenario. We are projecting net yields to decline over 7% in 2010. There is no good news on the capacity front. New ships are being built and old ships are not being scrapped.
CCL does not look any better on a free cash flow basis. The significant capacity additions and negative working capital will drive FCF down to a negative $700 million and $1 billion in 2009 and 2010, respectively. In prior years, as CCL grew capacity and had positive yields, they had a working capital benefit from growing customer deposits. This trend reversed itself in 2008 as the booking window narrowed, and yield growth came to a halt. Free cash flow turns positive in 2011, but even on these numbers the FCF yield is not compelling at only 3%.
Turning to the balance sheet, it is in pretty good shape at only 3x leveraged. However, if we are correct, leverage will increase in 2010 to 4x. Liquidity is fine for now although CCL will likely need additional financing in 2010 as we project a $600 million cash shortfall. We don’t anticipate this being a problem, especially since CCL had two export credits totaling $500 million awaiting insurance policies at the end of the March.
So what’s the appeal? Visibility has improved since CCL lowered prices and its guidance so 2009 bookings look fairly solid. At some point, investors need to focus on 2010 earnings, the ugly 2010/2011 capacity picture, and the long-term demographical challenge (see our 04/03/2009 note “THE TRIPLE THREAT TO CRUISERS”). As the focus moves forward we believe the market will be unwilling to pay 19x for this earnings stream.