Buy Royal Caribbean After The Recent Selloff

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With a share price 40 percent below the 52 week high and an price-to-earnings ratio dropping into the single digits range, are the shares of Royal Caribbean Cruises (NYSE: RCL) sitting at an attractive valuation for value investors? The results for an investment in a cruise line like Royal Caribbean are dependent on several macro-economic factors.

Important note: The January 13 sinking of the Costa Concordia and subsequent loss of life and media coverage has lead to a sell-off of cruise stocks. The Costa cruise line is owned by Carnival Corp. and Royal Caribbean will not be affected financially by the sinking of the ship. See the end of this article for some analysis concerning share values.

Royal Caribbean Cruises is the second largest global cruise company after Carnival Corporation (NYSE: CCL). Royal Caribbean owns approximately 40 cruise ships to Carnival's 100 and has a market cap of one-fourth the size of CCL. Royal Caribbean Cruises owns several cruise lines including Royal Caribbean International, Celebrity Cruises, Azamara Club Cruises, Pullmantur, CDF Croisieres de France brands and is a 50 percent joint owner of TUI Cruises. The cruise lines earn revenue from passenger ticket sales – 65 percent – and onboard sales of goods, casino proceeds, beverage sales and shore excursions – 35 percent.

Over the last 10 years, Royal Caribbean has increased annual revenues at a steady pace. From sales of $3.43 billion in 2002, revenue more than doubled to $7.55 billion for 2011. The only non-growth results was in the recession year of 2009, when sales dropped by 10 percent compared to 2008. In 2010, sales recovered and exceeded the results posted in 2008. However, Royal Caribbean has not been able to grow net profits in a manner similar to the gains in revenues. In the 10 year period, the most profitable year was 2005, when the company reported net income of $3.26 per share. In 2009, profits dropped to 75 cents per share. Outside of these two years, annual net income has ranged from $2.25 to $2.94 per share since 2004, including a projected net of $2.76 when the company reports 2011 fourth quarter and full year results on January 26.

Royal Caribbean, and the cruise industry in general, fight several headwinds which seem to cause profits to retrace just when it appears the company has started on a period of sustained growth.

  • Cruises are one of a range of vacation choices – and an attractive choice value-wise – yet when the economy goes into recession, slow consumer spending can significantly affect bottom line results.
  • Cruise companies buy a lot of fuel. The price of oil is hard to predict and most cruises are sold months in advance of the actual vacations. Rising oil prices can hurt expected profits.
  • Cruising is an international business. Currency exchange rates can help or hurt the bottom line when cruises sold in euros, Brazilian reals or Australian dollars are converted to U.S. dollars.

The result of the different outside influences which can effect the net profit results for Royal Caribbean is a very volatile stock. RCL carries a beta – volatility measure – of about 3. This means the stock is three time more volatile than the S&P 500 stock index. As oil prices, exchange rates and economic conditions change, traders are either buying or dumping RCL shares.

For 2012, the Wall Street estimates have Royal Caribbean once again earning more than $3.00 per share with a consensus earnings estimate of $3.16 per share. The estimates from 25 analysts range from a low of $2.61 – below the expected 2011 earnings – to a high of $3.90, which would be a record net profit for the company. Investors should evaluate the trends in crude oil prices – lower is better for RCL – and currency rates – generally a weaker dollar is better – to make an estimate on which side of the consensus the RCL earnings will actually fall. Royal Caribbean generates two-thirds of its net income in the high cruise season second quarter. Investors should listen to what company management reveals concerning booking trends during the fourth and first quarter earnings release conference calls. The summer season will make or break the company's profit results for the year.

The share value of RCL peaked at around $54 back in 2004, before the company generated its most profitable year to date. The share price trend was a steady decline until 2008 when the pending recession caused the value to drop off rapidly. Following the 2009 bear market, the share price peaked at about $34 in April 2010, dropped back to the low $20's, then ran up to a penny short of $50 in January 2011. In 2011, RCL was in a downtrend for pretty much the entire year.

If history is a guide, the share price of Royal Caribbean offers a strong possibility of a spring rally. Relatively good economic news in the U.S. and some sort of stability in Europe could be seen as signs the company will have a strong summer season. A multi-month run where the RCL share price runs up into the mid $40 range or higher would not be a surprise. Investors/traders who catch a spring and summer run in the stock should take profits or set tight stop losses before second quarter earnings are released in September. The history of Royal Caribbean as an investment shows it does not fair well as a multi-year hold investment.

The sinking of the Costa Concordia on January 13, 2011 will probably result in RCL selling off along with CCL. Some travelers may cancel their cruise plans, but the prediction here is the effects will be short term for Royal Caribbean and may even result in some customers switching to Royal Caribbean from the Carnival owned cruise lines – boosting the summer season returns. Aggressive traders may want to pairs trade – short selling CCL while going long RCL. 

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