Ryan Fuhrmann, CFA
February 6, 2007
Apparently, one of the primary drivers for a company is how it will perform over the next couple of months. Shares of Royal Caribbean (NYSE: RCL) fell more than 5% yesterday after the company released fourth-quarter and full-year 2006 results. Fourth-quarter results came in better than analysts had expected, and management’s full-year 2007 guidance of $3.05-$3.20 also appeared to mesh nicely with the $3.16 analysts had estimated. However, its first-quarter “wave period” is seeing weaker pricing for cruises, even though volumes are holding up well. As a result, Royal projects earnings of only $0.03-$0.08 for the first quarter of 2007, well below the $0.30 or so analysts were seeking.
In all fairness, the reduction in near-term expectations is worrisome, because the numbers are so far below analysts’ projections. But for those of us who believe predicting short-term fluctuations in a company’s fortunes is about as easy as predicting when the Chicago Cubs will next win the World Series, what’s important is the long-term outlook for a company.
As a shareholder in both Royal Caribbean and its larger peer Carnival Cruises (NYSE: CCL) (NYSE: CUK), I find the long-term opportunities of each compelling, and fellow Fool Rick Munarriz also likes the prospects of Steiner Leisure (Nasdaq: STNR), which runs many of the spas on cruise ships. Walt Disney (NYSE: DIS) operates a number of cruise ships, but other than that, there isn’t much in the way of direct competition. Royal and Carnival are the two primary competitors in a space that is hard to enter — cruise-ship construction costs run into the hundreds of millions of dollars. Plus, the related relationships with travel agents and others necessary to sell cruise vacations are difficult to replicate. Additionally, both companies are largely exempt from taxes, as their ships largely qualify as international operations.
Royal has been able to grow sales, earnings, and cash flow close to 10% on average over the past five years. I would characterize this growth as unspectacular but respectable, and operating cash flow exceeds reported net income by a wide margin, primarily because the cruise business is very capital-intensive and has high levels of depreciation and amortization.
I do see some drawbacks for Royal, including a high amount of debt — something that Carnival hasn’t escaped, either, though that company posts much higher net margins. Both are also subject to high fuel costs, which they saw in 2006. In addition, the hurricanes prevalent in the core Caribbean markets can wreak havoc on bookings and cruise outings.
Royal currently trades at 14 times forward earnings, very reasonable given the growth prospects, and has a 1.3% dividend yield. The stock is up almost 35% from lows reached during the overall market malaise and hurricane worries of late last summer, but it is still worth keeping an eye on. In my experience, short-term worries can prove to be solid entry points into firms with bright long-term prospects.
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Fool contributor Ryan Fuhrmann is long shares of Carnival and Royal Caribbean, but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.