What happened
UBS Group analyst Robin Farley released a bullish note on Norwegian Cruise Line Holdings (NCLH -0.10%) earlier Wednesday that also lifted other leading travel stocks Carnival (CCL 1.00%) (CUK 0.66%) and Royal Caribbean Cruises (RCL 1.22%).
As of 11:36 a.m. ET on Wednesday, shares of Norwegian Cruise Line were up 7%, with Carnival up 4.7% and Royal Caribbean up 5.2%. These stocks were outperforming the S&P 500 index, which was up 0.4% this morning. But much bigger returns could be in store as the industry continues to rebound from the abysmal performance during the pandemic.
Farley upgraded Norwegian Cruise Line shares to buy from neutral, as the luxury cruise line begins to see a strong recovery in bookings. Norwegian's outlook calls for bookings growth in 2023 on top of a 20% increase in capacity. Moreover, pricing continues to remain above pre-pandemic levels, which is a good sign for top- and bottom-line growth.
So what
While UBS didn't upgrade shares of Carnival and Royal Caribbean, Farley has a positive view of the entire sector. Not only are all three cruise lines reporting a rebound in revenue this year, but they are also meeting demand at higher prices than in 2019. This is good news for investors who have been worried about high inflation slowing the recovery of the travel industry.
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The outlook for pricing is pointing toward strong growth in profits, and that should ultimately drive higher stock prices for the group looking ahead to 2023.
Cruise stocks look significantly undervalued right now. Between 2012 and 2019, these stocks traded around a price-to-sales (P/S) ratio of 2. Royal Caribbean and Norwegian currently trade just above that level based on lower revenue over the last year compared to 2019. Carnival trades at a low P/S ratio of 0.8 because it is perceived to have the greater risk.
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However, looking at analysts' revenue estimates for 2023, all three cruise stocks trade at big discounts to their historical P/S range. Improving margins are a catalyst for growing earnings per share. This could push the P/S ratios for the group well above their current forward P/S multiple of less than 1.
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Analysts currently expect Royal Caribbean to achieve an operating profit margin (earnings before interest and taxes) of 18.9% by 2024, up from negative 5.9% in 2022. Norwegian and Carnival are expected to achieve an operating margin of 18% and 15.6%, respectively, in two years -- also up from negative margin expected in 2022.
Now what
The risk-to-reward profile for top cruise stocks is starting to look very attractive. These companies' high debt burdens are becoming less of a concern as consumer demand rebounds. All three companies took advantage of the downturn to make improvements to drive higher returns on invested capital and capture more growth, but which one is the better buy?
UBS likes Norwegian's risk profile, since it is a U.S.-centric cruise line. This means Norwegian is not as vulnerable to the negative impact on its financial results from a strengthening U.S. dollar. Management likes serving a U.S. customer base because it tends to book earlier, which provides greater sales and pricing visibility.
Carnival might offer the most upside, given its lower valuation, but it also carries more risk. It is more dependent on European travel, so the recent strength in the dollar could negatively impact its earnings results for U.S. investors.
Overall, investors might want to forget about picking winners and losers here. Investing an equal amount in all three cruise line stocks is the safest way to go.
