Fitch Ratings has upgraded TUI Cruises GmbH's (TUI) Long-Term Issuer Default Rating (IDR) to 'B+' from 'B'.

The Outlook is Positive. It has also assigned its proposed five-year senior unsecured notes an expected rating of 'B-(EXP)'. Fitch has also upgraded TUI's outstanding senior unsecured notes to 'B-' from 'CCC+'. The Recovery Ratings on both notes are 'RR6'.

The IDR upgrade to 'B+' reflects Fitch's expectations of continued EBITDA growth, driven by a recovery in occupancy to pre-pandemic levels and the ramp-up of new vessels, as well as price increases offsetting cost inflation. The rating also incorporates the company's solid business fundamentals, with a strong market position as the second-largest cruise line in Europe, a diversified offering, one of the industry's youngest and most efficient fleets, and a significant share of advance bookings supporting high operating margins.

The Positive Outlook reflects our expectation that EBITDA leverage will return to below 5x in 2025, after temporarily increasing in 2024 to 6x due to debt raised to finance two new vessel deliveries. We also forecast TUI's pre-dividend free cash flow (FCF) generation to improve once capex normalises.

The 'B-(EXP) senior unsecured rating is two notches below the IDR, reflecting material prior-ranking debt, which is mostly related to secured financing of vessels. The assignment of final rating is contingent on the receipt of final documentation conforming to information already reviewed.

Key Rating Drivers

Refinancing to Extend Maturities: Proceeds from the proposed notes will be used to partially repay TUI's KfW loan, ECA vessel financing deferrals and a secured term loan, extending TUI's debt maturity profile. The next large maturity is in May 2026, when EUR523.5 million notes are due. We assume refinancing will be supported by expected deleveraging and business growth.

Solid Revenue Recovery: In 2023, TUI demonstrated a strong recovery post-pandemic, with a ramp-up of occupancies, translating into revenue of EUR1.9 billion and Fitch-adjusted EBITDA of EUR599 million, ahead of Fitch's forecast. We expect TUI to maintain this performance, as advance bookings already provide a good level of visibility for revenue in 2024.

Improved Deleveraging Prospects: TUI has made significant progress on deleveraging as its EBITDA leverage declined to 4.9x in 2023 (2022: 10.1x), below our positive rating sensitivity of 5x. We expect the spike in TUI's EBITDA leverage to around 6x in 2024 to be temporary as it will be driven by new debt to finance its two vessel deliveries. As new vessels start contributing to EBITDA, we expect EBITDA leverage to fall back to below 5.0x in 2025, which, in combination with TUI's steady operating profile, supports the Positive Outlook.

Conversely, a delayed ramp-up of added capacity, occupancies trending below Fitch's assumptions or weaker-than-expected margins could disrupt the deleveraging path and weaken the prospect of the rating upgrade.

New Vessels to Support Growth: The Positive Outlook hinges on TUI's capacity expansion with the addition of three new ships for 2024-2026. Supportive demand and constrained global cruise ship supply due to delivery times should underpin TUI's ramp-up of operations in these new additions. We expect these to be as profitable as the current fleet in light of proven synergies, lower fuel consumption and economies of scale. Delayed vessel deliveries or postponed itineraries would, however, derail the deleveraging path and may negatively affect the rating.

Strengthened Cash Generation: TUI generated positive FCF of EUR436 million in 2023 and we expect strong cash generation to resume in 2025 after being negative in 2024 due to significant capex related to fleet expansion. We do not rule out that positive FCF could be allocated to shareholder remuneration as dividends have been suspended since the beginning of the pandemic. However, the rating assumes these would be reasonable and aligned with TUI's net debt/EBITDA target of 3.5x-4x.

Strong Business Profile: TUI has a strong market position as the second-largest German cruise line with a market share of around 30%. Its concentrated customer base enables it to better adapt its product offering to customer preferences, resulting in a high level of repeat bookings at around 60% of total customers in 2023. This allows TUI to maintain its current market position, while growing via additions of new ships from 2024.

Moderated Margin Amid Luxury Integration: TUI's premium product offering enabled it to generate an industry-leading EBITDA margin of close to 40% in 2019. However, due to the integration of the luxury segment (Hapag-Lloyd Cruises acquired in 2020) and ongoing inflation, we assume EBITDA margins will trend lower to 30%-33%, albeit remaining strong for the industry.

Standalone Rating: TUI is rated on a standalone basis despite its 50% ownership each by TUI AG and Royal Caribbean. Both the shareholders reflect TUI as a joint venture in their financial accounts with no relevant contingent liabilities or cross guarantees between the owners and TUI. TUI manages its funding and liquidity independently. Operational related-party transactions with the owners, primarily in marketing and technical operations, are conducted on an arms-length basis.

Derivation Summary

Fitch does not have a specific Ratings Navigator framework for cruise operators. We rate TUI based on our Hotels Navigator due to the similarity in key performance indicators and demand drivers.

TUI has a weaker market position than major cruise operators, such as Royal Caribbean, Carnival and NCL Corporation (Norwegian Cruises), whose fleet capacity and EBITDAR are significantly higher. However, TUI benefits from recognised brand awareness and diversification into the luxury segment, where competition is less intense.

TUI showed a faster recovery than peers, as it returned to pre-pandemic occupancy levels in 2023 despite exposure to its core German market. TUI has also deleveraged faster than its competitors: it was one of the first cruise operators to resume operations during the pandemic, which led to lower liquidity needs and better sourcing of staff, which benefited margins.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Low single-digit ticket price growth for 2024-2027

Occupancies of 98.5% for Mein Schiff and 77% for Hapag-Lloyd Cruises in 2024, and improving marginally for 2024-2026

EBITDA margin at 31.7% in 2024 and improving gradually to 32.8% in 2027

Restricted cash of EUR40 million

Major one-off capex cash outlay for fleet expansion of EUR1.4 billion in 2024

Recovery Analysis

The recovery analysis assumes that TUI would be reorganised as a going-concern (GC) in bankruptcy rather than liquidated. Ships can be sold for scrap but this typically does not occur until near the end of its useful life (30-40 years) and at a much greater discount than mid-life ships. This is due to the inherent cash flow generating ability of the ships, even older ones, which can be moved into cheaper/ less favourable locations as they age.

We have assumed a 10% administrative claim.

We assess TUI's GC EBITDA at EUR632 million, which is higher than its EUR599 million Fitch-adjusted EBITDA in 2023, as we incorporate the contribution of new vessels.

The GC EBITDA estimate reflects Fitch's view of a stressed but sustainable, post-reorganisation EBITDA level on which we base the enterprise valuation (EV).

An EV multiple of 6.5x EBITDA is applied to the GC EBITDA to calculate a post-reorganisation EV. This reflects market M&A multiples for cruise operators of 9x-20x over the last 20 years, though these assets typically do not change hands frequently.

TUI's KfW loan, vessel-backed loans (including loans scheduled to be drawn for new vessels over 2024 and 2025) and revolving credit facilities (RCFs including a term loan that will be converted into a new RCF) are secured and rank ahead of the existing EUR523.5 million senior unsecured notes in our waterfall-generated recovery computation. The RCFs are assumed to be fully drawn in a default.

Our waterfall analysis generates a ranked recovery for the EUR523.5 million senior unsecured notes in the 'RR6' band, indicating a 'B-' rating, two notches below the IDR. The waterfall analysis output percentage on current metrics and assumptions is 0%.

The proposed senior unsecured notes will rank equally with the existing senior unsecured notes. TUI plans to apply the notes proceeds to repay prior-ranking debt but we view this change in debt structure as neutral for recovery prospects of senior unsecured bondholders. Pro-forma for the transaction, our waterfall analysis generates a ranked recovery for senior unsecured notes in the 'RR6' band. As a result we rate proposed notes at 'B-(EXP)', two notches below TUI's 'B+' IDR. The waterfall analysis output percentage on current metrics and assumptions is 0%.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

Timely and profitable capacity growth with occupancy and cost control leading to growing EBITDA and EBITDA margin trending towards 33%

EBITDA leverage sustained below 5.0x, supported by a consistent financial policy

Positive pre-dividend FCF generation trough the capex cycle

Factors that Could, Individually or Collectively, Lead to a Revision of the Outlook to Stable:

Lack of visibility of EBITDA leverage declining towards 5.0x post-2024

Factors That Could, Individually or Collectively, Lead to Downgrade:

Pricing power and occupancy weakness leading to EBITDA margin falling below 28%

EBITDA leverage sustained above 6.0x

EBITDA interest coverage below 3.5x

Liquidity and Debt Structure

Adequate Liquidity: We assess TUI's liquidity at end-2023 as adequate, despite insufficient Fitch-adjusted cash and cash equivalents of EUR80 million and EUR342 million undrawn credit lines to cover EUR502 million of short-term debt and expected negative FCF. This is because negative FCF is driven by high capex related to new vessels, for which funding has been pre-arranged. TUI plans to draw down EUR1,272 million from the vessel funding in 2024.

We also expect liquidity to improve following the bond placement as proceeds will be used to repay part of its near-term debt. The company also intends to convert the remaining part of the term loan into a RCF, thereby increasing the total amount of RCFs to EUR592 million (of which EUR261 million will be drawn post-transaction) until December 2025 (with a one-year extension option).

Issuer Profile

TUI Cruises is a medium-sized cruise ship business with two brands, Mein Schiff and Hapag-Lloyd Cruises, operating in the premium and luxury/expedition segments of the market, respectively. Its customer base is primarily in Germany.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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