We are raising our fair value estimate of 
Carnival (CCL) shares to 3,431p because of updated guidance from the company, which for the full year included weaker current currency yields (due to foreign exchange headwinds) and better cost leverage than previously anticipated (particularly related to fuel). While second-quarter expenses are expected to tick up due to project spending causing more dry dock days, lower fuel prices are offsetting these costs, helping to generate strong free cash flow at the enterprise level.
Our fair value estimate implies a fiscal 2015 price/earnings ratio of 20 times and an enterprise value/EBITDA multiple of 13 times. This is versus a historical five-year median P/E of 19 times and an EV/EBITDA multiple of 11 times.
We expect that as supply/demand characteristics shift over time, increases in pricing should help Carnival. We believe pricing can grow in the low-single digits over the medium term (although we forecast them to fall 4% in 2015 current currency) as capacity growth remains under 5% annually over the next decade. In addition to slower capacity growth, we expect occupancy rates of 102%, which is slightly lower than historical rates, as we expect the firm to hold pricing firm (sacrificing some occupancy). Longer-term, we see pricing and costs stabilising at a low-single-digit rate, as the cruise industry remains in a stable phase of its life cycle with rational competition.
We believe Carnival's operating margins and returns on invested capital will begin to rise in 2015. We forecast operating margins to expand at a measured pace, helped by better pricing and increasing cost leverage as costs are spread across a larger and more fuel-efficient fleet. If the economic environment were to improve dramatically, operating margins could benefit and get close to rates achieved in good times. We have them rising to over 20% during the next decade. Carnival has generated ROICs above our weighted average cost of capital assumption of 10% in the past, and we believe it will be able to do so again if the economy doesn't falter. Given the capital-intensive nature of the business, we think mid-teen ROICs might take some time to achieve, and we don't foresee ROICs exceeding the weighted average cost of capital until at least 2018.
This is an excerpt from the Morningstar Analyst Report on Carnival, available to Premium members. Not a Premium member? Not a problem! Get instant access to thousands of reports on stocks and funds when you take a free 14-day trial.
