Full Speed Ahead for Cruise Stocks
Ahoy, investors. Cruises have never been more popular. A record 10.5 million people set sail from North America in 2004, and bookings are running ahead of that pace this year. That should be great news for Carnival and Royal Caribbean, which control more than 70% of the market. But rising oil prices have sunk the stocks.
(MONEY Magazine) – what the bulls say
• More than half of cruise passengers are over 50, and a steady stream of boomers are entering those prime cruising years. This affluent, aging population is the big reason analysts expect both Carnival and Royal Caribbean to see earnings growth of 20% or more in 2005, and 15% a year, on average, for the next few years. "Baby boomers are retiring and have a lot of money to spend on leisure," says Jake Balzer, an analyst with the Miami brokerage Guzman & Co.
In fact, demand is so strong that cruise lines have had no problem filling berths even as they raise prices. Royal Caribbean, for example, recently reported that net yields, which measure sales minus travel agent commissions and other expenses and are considered a good measure of pricing power, should increase 6% to 7% in 2005.
Kent Gasaway, manager of the Buffalo Large Cap fund, which owns shares of Carnival and Royal Caribbean, believes both should be able to keep raising prices because the cruise industry is not launching as many new ships as it has in years past. Plus, he adds, competition is minimal because these two lines have bought up so many rivals.
what the bears say
• Cruise ships need fuel to leave port, and with oil prices setting repeated records this year, Carnival and Royal Caribbean have already announced that higher transportation costs will eat into profits in the near term. As a result, analysts have lowered 2005 and 2006 earnings estimates a bit in recent months.
As long as oil prices remain high, the stocks could stay stuck at the dock. "Investors should wait for the cruise lines' stock performance to improve relative to the market," says Derek Rollingson, manager of the Icon Leisure & Consumer Staples fund, which sold its stake in both stocks earlier this year.
What's more, Tim Fidler, director of research at Ariel Capital Management, contends that some investors are overly bullish about how much higher cruise prices can go. If travelers balk at paying more money, the stocks could suffer. "When too much attention is put on pricing growth, we get a little nervous," he says. His concern: Investors counting on higher prices are going to be disappointed. His firm recently trimmed its stake in Carnival in the Ariel Appreciation fund.
• It's unlikely that oil prices will prove to be a major blow to profits over the long term, even if they are a drag on the stocks now, since fuel eats up only 6% to 7% of revenue at Carnival and Royal Caribbean. "Fuel costs have put a little bit of pressure on earnings growth, but Carnival will still be a strong earnings generator over the next few years," says Larry Puglia, manager of T. Rowe Price Blue Chip Growth, a MONEY 50 fund that owns Carnival stock.
Plus, share prices already reflect these worries. Puglia says that Carnival, trading at $51, or 19 times 2005 earnings estimates, is a good value. Analyst Balzer thinks that Royal Caribbean, at $45, or 16 times 2005 earnings estimates, is a slightly better value. Both stocks, he says, deserve to trade at a P/E of 24, or 1.6 times their projected long-term growth rate and in line with historical averages. At that level, each stock would be worth more than $65.