An Investment Opinion
Carnival is not alone. Many of the publicly traded cruise companies have seen their share prices sink in the same time period, including Royal Caribbean Cruise Lines (NYSE: RCL), Norwegian Cruise Lines (NYSE: NRW), and American Classic Voyages (Nasdaq: AMCV). It's a bit strange, because it's not like cruises are yesterday's vacation choice. We're not trying to figure out how to turn around the tourism industry in Gary, Indiana here.
But the losses racked up by the cruise companies' shares are noteworthy. They may also provide an excellent opportunity for investors to take advantage of temporary uncertainty in a dynamic growth industry.
Price Performance of Selected Cruise Stocks
Company Price as of Price on % Change
Carnival (CCL) 48 22 1/4 -54
Royal Caribbean (RCL) 49 1/4 26 -47
Am. Classic Voyages (AMCV) 31 1/4 25 -19
Norwegian Cruise Lines (NRW) 17 15 1/2 - 9
Let me put in a sidebar here, apropos of nothing. I'm not much for cruises. I think I'd rather watch paint dry than sit on a floating continent for a week. That said, there can be no denying -- as my wife and I noted as we negotiated the sea of blue hair, sunburns, and bad polyester prints at Fort Lauderdale International Airport the other day -- that cruises are hot, they are big business, and millions of people are completely addicted to them. So I'm not the cruise industry's target market, but that's OK. There are several boatloads' worth of "not me's" out there.
Cruise company executives are fairly mystified by the drop in share price, but they are aware of the culprits. And I, like them, believe that the culprits only mask the bigger story of growth. The chairman of Carnival quipped last week that perhaps the problem lies in the fact that his company is profitable, in this environment where growth seems to be more important than earnings.
First and foremost of the risk factors is the fact that the cruise companies have increased their capacity by 17,000 beds over last year, an increase of more than 10%. In a business with perfectly perishable commodities like beds (as soon as the boat pulls away from dock, those unused beds are unrecoverable revenues), such a large increase often places a great deal of short-term pressure. Since the companies have quarterly revenue comparables they must meet, the need to fill this capacity right away looms large. This could lead to deep discounting, causing the companies to sacrifice earnings for the sake of revenues.
Well, sure, maybe. But what we are talking about here is an absorption problem, not one of declining growth. Currently the cruise companies have commitments for $15 billion in new ships, which will add even more to the supply. But these behemoth vessels are not the type of things one can just pick up on a lot. There is a necessary predictive function required by cruise companies to ensure that they have the floating stock capable of meeting the needs of the market. And several companies, Carnival among them, are confident that they will be able to fill their added capacity this year at higher prices.
The reason is macroeconomic in nature. The United States and many other economies have added huge amounts of wealth over the last three years. This wealth, plus the ever higher number of Baby Boomers entering the "leisure class," makes for ready made growth in the market for such big-ticket luxury items as cruises. So even if these companies suffer poor comparable profit margins, the major reason is in the place we Fools like to see it: reinvested capital. Boats cost money. Big money. Cunard Lines (a subsidiary of Carnival) last week placed an order for a $700 million dollar boat, the Queen Mary 2. Upon completion it will be the largest and longest ocean liner in history. These boats must be ordered years in advance, and although much of the payment for them is deferred, the commitments are in place.
Will the addition of capacity cause swoons in profit margins? Maybe, particularly if the economy does a downturn. But that's true everywhere, isn't it? If the economy cools off or drops precipitously, the growth prospects of the majority of all companies will fall commensurately. But whereas companies with really light business models (ones requiring small levels of operating capital) can expect only slower growth, ones taking on debt to maintain a huge asset base can get slaughtered. Cruise companies fall into the latter category.
But here's the thing. Right now these stocks come pre-slaughtered. They've already been rocked, in the midst of a huge expansion of their revenues. Carnival, in fact, already has several class-action lawsuits filed against it. (Note: Somehow the same law firms always come up for class-action suits. Milberg Weiss. Desmond Law Firm. I'd call these people bloodsucking jackals, but I wouldn't want to insult the hardworking jackal community. I think that the biggest beneficiaries of class action suits are the personal injury lawyers, since the class-action lawyers make them look downright noble by comparison.)
Carnival has taken the opportunity of the sale on its stock to announce a repurchase of $1 billion worth of shares to retire them. Although I do not normally condone such actions out of hand, as they tend to be used by desperate companies trying to prop up share prices, I think that Carnival is on the right track here.
Other risks are plentiful. For example, the skyrocketing price of fuel. The fuel costs for the largest carriers are around 5% of the total operating expense, down from 25% in the 1980s, but the timing is not good. If you couple the potential for price cuts due to perceived overcapacity and the increase by some 60% of the cost of fuel, the assault on profit margins is severe. More severe could be if fuel prices keep airfare rates high, causing people to defer travel plans.
Add to these factors the continued rise in interest rates. The majority of the ocean liners are built in Europe, and so the rise in U.S. interest rates does not necessarily correlate to higher finance cost. But a significant percentage of the banking facilities used by these companies are U.S.-based, and interest rates have been rising (at differing levels) overseas as well. So while the debt taken on by the cruise companies may have been taken on prudently, the cost of debt could begin to make these obligations seem weightier.
Still, I don't believe that the risks associated with the above factors are significant enough to warrant the haircut these stocks have taken. Cruising is a hot ticket, it is high margin, and the companies in the business are profitable in their operations. Better yet, the growth potential for cruising is still huge, with the number of people who went on a cruise last year being dwarfed by the number of tourists traveling to Orlando or Las Vegas. (I couldn't find statistics on Cancun, the third of the triumvirate of McVacations. Told you I was a travel snob.)
These companies provide a compelling potential investment, as the barriers to entry for the mega-cruisers are getting higher and higher. And how Foolish is it to grab ahold of an investment that has high growth, significant repeat business, and high brand loyalty?
You tell me.
Bill Mann, TMFOtter on the Fool Boards