All Aboard?

 | Apr 09, 2012 | 3:30 PM EDT
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It's good to be home. Last week, we took advantage of our children's spring break, and fact that our eldest is off to college in the fall to take a Heller family "last hurrah" vacation, aboard a Royal Caribbean RCL cruise ship. Other than the flood we discovered in the kids' room at 3:30 one morning, it was a great week.

It's hard not to be at least somewhat enamored with the cruise industry when you are aboard one of those great ships, and witness the amount of spending that is taking place. From the gift shops to the lounges to the excursions, game rooms and casinos, our ship, Explorer of the Seas, appeared to be a cash-making machine -- and that's not even including the price of the cruise itself, which represents the bulk of RCL's revenue (73.3% in 2011). Extrapolate that to the company's 39 ships, and it comes to more than $7.5 billion in revenue for 2011. The company bottom-lined $607 million of that, for a net margin of 8.1%. But that's way down from 2005 (14.6%) and 2006 (12.1%), and is less impressive when you consider that the company, which is incorporated in Liberia, does not pay income taxes.

While the company and industry has come a long way since being dogged by the recession in 2008 and 2009, it's been a consumers market. Cruising has been very affordable in recent years, and the cruise lines have had little in the way of pricing power. That's great if you are looking to take a vacation, but not as great for investors -- at this point anyway. That is, unless you saw past the market doldrums three years ago, and picked up Royal Caribbean for less than $6 a share. The stock subsequently ran up to $50 in early 2011, but it has since fallen to about $28.

A couple of issues have weighed on the industry recently, with the Costa Concordia disaster being the most horrific. Owned by Carnival CCL, the 800-lb. gorilla in the industry with 99 ships, the sinking of this ship off the coast of Italy has hurt bookings, and was also a black eye for the industry. In time, this will pass, but the significant loss of life raised concerns for an industry that has been considered fairly safe in modern times.

Rising fuel prices are also an issue. While cruise ships burn a lower quality, lower cost type of fuel (bunker), the price has risen dramatically. Fuel costs represented 15.47% of RCL's 2011 operating expenses, up from 14.51% in 2010. The company is estimating $889 million in fuel costs for 2012 (up from $765 million in 2011), and is 55% hedged. There's also always the possibility of imposing fuel surcharges on passengers, but you still have to fill the cabins with passengers, and pricing is an issue.

At this point, cruising remains a fairly inexpensive vacation choice for consumers. From what I've seen, the consumer is still in the driver's seat, at least for now, in terms of pricing. That certainly may change if the economy improves, and we start to see some changes in the employment picture.

But as an investor, I'm staying on the sidelines. While RCL is currently trading for 10x trailing earnings and 10 forward earnings, and just 0.72 times book value, there is a bit too much uncertainty for me. Likewise with shares of Carnival, which trade at 15x trailing earnings, and 13x forward earnings, and just over book value. While Carnival's margins are better than RCL's (12.1% net margin in 2011), and the stock yields a solid 3.3%, there is still a pall over the company at this point, given the Concordia disaster.

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