OSW - OneSpaWorld: Encouraging Trends For The Medium Term

2023-12-21 10:36:00 ET

Summary

• OneSpaWorld Holdings has seen a significant increase in its stock price, more than doubling year-to-date, in line with the recovery in the cruise industry, where it provides health and wellness facilities.
• The company's market leadership position, long-term partnerships with major cruise providers, and focus on higher ticket growth areas provide both stability and potential.
• Its market multiples are less clear about whether the stock is an outright buy, but its prospects do indicate it's a medium-term Buy.

The health and wellness centre provider for cruise ships OneSpaWorld Holdings (OSW) has more than doubled year-to-date [YTD], with an increase of 111%, in a year that has seen a recovery for the cruise industry. It also far exceeds the already healthy uptrend in the consumer discretionary sector. The S&P 500 Consumer Discretionary index is up by 43% .

This leads to the question of whether OSW can continue to rise in 2024, especially considering that its focus market is North America, which is expected to see an economic slump next year.

Market leader in a growing industry

But before we get into the prospects for OneSpaWorld, a look at what makes it uniquely positioned. The first is its history of partnership with leading cruise providers, a history of over 20 years for all but one (see chart below).

Importantly, it provides services across all the ships for the three big cruise providers, Carnival Corporation (CCL), Royal Caribbean (RCL) and Norwegian Cruise Lines (NCLH). To be more specific, it has a 90% market share for outsourced spas on cruises, indicating limited competition for it (see Pg 5 of the link). The industry dominance along with long-term relationships with cruise providers gives it a high level of stability.

Further, the cruise industry tends to be resilient even during recessions (see chart below), which is a positive considering that the next year is expected to be a challenging one. The pandemic, of course, was an exception, which halted their operations and resulted in a 78% decline in OSW's revenues during 2020.

But next year would likely be nothing like that. For one, unless there's another (unlikely) pandemic, travel would still be permitted. And second, it's expected to be a slowdown, which differs from a recession in that there's no contraction in GDP, but only a winding down of growth. As the chart below shows, even during recessions, the business has grown. So a slowdown is even less to sweat over.

The financials

This means that cruises would build up on the growth already seen this year, which is notable. As of the second quarter of this year (Q2 2023), passenger bookings were up by 33.8% from Q2 2019, the last pre-pandemic year.

The positive industry-level developments are also reflected in the company's own numbers. For the first nine months of 2023 (9M 2023), it saw a 59% year-on-year (YoY) increase in revenues and its operating profits grew by an eye-popping 837%. The profit recovery looks particularly significant since last year the company was still recovering from the debilitating effects of the pandemic. In fact, in Q1 2022, it had posted an operating loss.

Commensurately, the operating margin has improved to 6.8% (9M 2022: 1.2%). While the margin is higher than the average of 5.6% for the past five years when it has clocked a profit, it is still lower than the almost 9% seen in 2018 indicating room for improvement.

It cannot be assumed, however, that it will necessarily improve because the company attributes cost increases only to the increase in requirements for products and services. If there were one-off or time-limited cost increases on say, more marketing, it would be easier to make a case for higher margins.

The net income discussion gets a bit more involved, and not entirely as positive as for operating profit. The GAAP net profit is down by 92%, on account of a change in the fair value of warrant liabilities. However, the non-GAAP figure, which removes this influence from the equation, has risen by an exceptionally strong 256%.

The market multiples

To assess where the stock valuations stand, here I consider other cruise companies, which are not exactly peers but they do reflect where the industry multiples are. Also, considering that OneSpaWorld has a lion's share of the business in its niche, it doesn't have bonafide competitors.

I would usually consider the non-GAAP P/E as the yardstick, but cruise companies have just become profitable on a net basis so the figure is unavailable for them. For this reason, here I consider the trailing twelve months [TTM] price-to-operating income ratio, which is at 28.4x for OSW.

The stock's ratio doesn't compare too badly against the three big cruise stocks. It's lower than that for CCL at 61.8x and NCLH at 43.1x, though it is higher than RCL at 22.2x. On average, the industry ratios indicate that there's a huge 65% upside to the stock.

However, the forward multiples don't look quite as positive. Here, I consider the non-GAAP forward P/E for 2024 which is at 18.2x for OSW, compared to CCL at 20.3x, RCL at 13.7x and NCLH at 16.4x. With the average forward P/E for cruise providers at 16.8x, an over 10% downside is indicated for OWS.

What next?

The downside indicated by the forward ratios, however, is far lower than the upside indicated by the TTM multiples. I'm more inclined to veer towards the TTM multiples right now, considering that the cruising industry is just getting back on its feet and its expansion may well be more than is expected at present.

Further, OWS is now focusing on its medi-spa business which focuses on aesthetic treatments like acupuncture, botox and fat reduction. These are higher spend services, which could well impact margins positively.

However, this might not reflect on the stock's performance in the near term. The speculated increased margins might take time to show up. In the meantime, the stock has run ahead of what its forward estimates indicate. These are subject to revisions, but that remains to be seen.

For this reason, a medium-term view on OSW is a good idea. The company has a market leadership position, positive trends are driving the cruise industry and its financials are healthy. The TTM multiples too indicate the upside. Considering that there are more positives than not to the stock, I'm going with a Buy rating with a 3-5 year investing horizon.

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