Will You Sail Away With These Companies?

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

After what felt like the longest winter ever, summer is just around the corner. For many, this means a chance to travel to exotic locations, spend time with the family, and enjoy the sunshine. For some people, this will involve cruise ships, which have become increasingly popular over the last decade thanks to huge investments from cruise giants Royal Caribbean (NYSE: RCL), Carnival (NYSE: CCL), and even Disney (NYSE: DIS). However, recent problems with some cruise ships, including fires and engine failure, have had people re-thinking cruises as vacation options, and for investors it has meant sinking share prices in the short-term.

Small industry, big costs

Unlike other industries, the cruise ship industry is small in terms of the number of competitors. This is mostly due to the costs of owning and maintaining a cruise ship that is both profitable and comfortable for passengers. The average price to build a cruise ship can run anywhere from $420 million to nearly $1.5 billion, which is a big investment for just one unit. This tends to limit the number of entrants into the marketplace, and since it’s a small industry, it means any negative publicity with cruise ships tends to have a ripple effect across the whole industry. Disasters with ships like the Costa Concordia and the Grandeur of the Seas have hurt the cruise ship market, as well as led to massive costs in repairs and marketing to try to regain the public’s trust.

Ship safety hurting company profits

Following Royal Caribbean’s recent problem when its ship, the Grandeur of the Seas, caught fire, the share price impact was immediate. It came as a precursor to the company losing 10¢ per share in earnings, which isn’t good for the company headed into the peak summer season, when ships make their money for the year. Thankfully for the company, Moody’s hasn’t cut its credit rating from Ba1 after this downturn,. This will enable the company to borrow money, if need be, for repairs, as well as any expenses that will come from regaining passengers in the future, which will limit damage to the share price.

As troublesome as that was for the industry, the biggest headache came from Carnival after a fire on the ship, Triumph, left 3,100 people stranded at sea, leading to serious questions regarding the safety of cruise ships. Company reports have also shown a decline in revenue per passenger, despite an increase in bookings due to decreased cabin prices, leading the company to drop its profit estimates to $1.45-$1.65 per share, far below analysts’ expectations of $1.99 per share. Part of this downturn has also been aided by increased fuel costs and less-than-favorable exchange rates. While that hurts the entire industry, Carnival has also had to increase marketing expenses to win back consumer confidence, which may turn out to be a long-term profit bleeder.

Disney impacted as well

A relatively new entry into the cruise business, Disney, has also taken a hit. Its new cruise ship, Fantasy, is expected to bring in lower earnings this year, though the company insists that this is a natural drop for a ship’s second year at sea. While that may be true, it is possible that recent bad headlines associated with cruise ships have taken their toll on Disney’s cruise enterprise, as well as the increase in fuel costs that were partially responsible for Carnival’s problems.

However, Disney is more diverse than the other two companies. It has an entire network of entertainment ventures that help the company’s bottom line, and alterations in the cruise industry won’t have as much of an effect, positive or negative. Going into summer, expect Disney to benefit from sales at the box office and at its theme parks more than from its cruise ships.

To invest or not to invest?

For those who have invested in cruise ship companies over the long-term, this summer won’t be nearly as good as past summers. There will still be movement among the three companies, but it doesn’t look like the recent economic upswing will translate to cruise ship passengers as much as it should for other economic sectors.

Total liabilities for all three companies have risen over the last three years, even though long-term debt has decreased. Royal Caribbean seems to be the steadiest company so far, posting only a 1% increase in liabilities since 2011. This comes with an E/P (earnings-to-price ratio) of 0.63%, the lowest of the three companies, as well as a 0.56% return-on-equity, which is due to an increase in assets and a drop in shareholder equity.

Carnival, despite its problems, is still posting an E/P of 5.85%, a good yield, and it’s a cheap buy with a forward P/E of 14.20, but these statistics may be misleading. Liabilities have increased by 5.35% over two years, and that may increase due to ship problems, which could be a red flag down the line. Return on equity is at a respectable 6.25%, though tempered expectations may result in a bit of a sell-off from stockholders. A downturn in profits will lower that ratio a bit, especially given the nature of the Triumph disaster. It is so far the only one of the three that has underperformed the S&P 500 over the last five years, which makes it less attractive as well

Disney had the biggest liability increase at 10.89% over two years, but still posts an E/P of 5.21% and a return-on-equity of 15.43%. It’s more expensive than the other two, with a forward P/E of 16.09, but probably has a better chance for long-term gains thanks to other, more successful ventures like the much-anticipated release of “The Lone Ranger” in theaters this July.

Bottom line

Disney appears to be the better bet right now simply because of its size and diversity, which can absorb cruise ship industry problems. There may be better times ahead for cruise companies once the kinks are worked out and consumer confidence goes up, but right now is not the time if Carnival’s estimates are a sign of an industry-wide problem. 

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John McKenna has no position in any stocks mentioned. The Motley Fool recommends Walt Disney. The Motley Fool owns shares of Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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