THE HEDGEYE EDGE
We see a divergence in both pricing and the overall fundamental backdrop through Wave Season creating an attractive risk-reward for us to add new top short Carnival (CCL). CCL is seeing increasing pricing pressure that could suggest the Street’s lower 2019 yield bar isn’t low enough.
For the cruise stock industry, the Macro landscape could ultimately become more challenging. Our Macro team sees the rates of change in growth and inflation suggesting Quad3-Quad4 set up through Q3 2019, which is historically negative for cruise stocks. (Quad 3 = U.S. Growth slowing, Inflation accelerating; Quad 4 = U.S. Growth and Inflation slowing). Quad4 is typically an OK environment for cruise stocks (per our 15-year backtest), but Quad3 becomes a much more challenging stylistic environment for cruise stocks.
Hedgeye Gaming, Lodging and Leisure has generally been cautious on the cruise space since the beginning of 2018, as we didn’t think the stocks would work in a yield decelerating environment. Looking ahead, we see diverging trends in the space, which makes us more willing to get more active with individual stock picks.
Worsening sequential pricing power in the Caribbean for CCL indicates a slow start to Wave. Is CCL a market share loser? CCL Caribbean yields are currently up 1% YoY but trends are slowing. The CCL issues appear to be more brand specific and could be a consequence of intensifying competition in the contemporary segment and a lack of brand pricing power in the same-store base.
Outside the Caribbean, CCL’s highest exposure is to the weaker European sourced business. Europe accounted for 31.6% of CCL’s revenues in 2018, up from 30.9% in 2017. We mentioned several times that European sourced ships for CCL were underperforming in Europe in 2019. That trend hasn’t improved during Wave Season. Meanwhile, our survey data suggests Alaska remains the weakest market we track.
With headwinds in both Europe and Alaska, we expect 2019 yield growth to come in below 2%, or less than half the average growth from the previous 4 years. Europe and Alaska are the biggest drivers of the deceleration but CCL’s new ship premiums are also not enough to lift yield growth substantially higher.
Under a slowing yield environment and rising capex (maintenance and new ships), it is increasingly difficult for CCL to accelerate their share repurchase plans. We see lower buybacks in 2019 and 2020.
At the same time, CCL’s leverage ratio is increasing, even if they chose not to buy back stock. As CCL’s leverage increases and the spread vs. its peers narrows, its valuation premium should shrink too. If CCL buys back $1.1bn in stock in 2019 as we estimate, then the company could be in danger of exceeding their target leverage range in 2020 (2.5x at the high end). We think management would prefer to pare back the buybacks rather than lever up. The rinse and repeat FCF/buyback story might have a major hole.
ONE-YEAR TRAILING CHART
