Don't Bail On Leisure Stocks Just Yet

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

After the financial crisis and a decade’s worth of flat median income, investors are rightfully reserved about stocks targeting the leisure market. In many instances this has led to stocks becoming under-appreciated - even those that showed positive fundamentals during strong macro periods. Accordingly, I recommend holding out in some leisure stocks and backing others.

Carnival: No Longer Attractive, But Not Because of Costa Concordia

After the horrific sinking of Costa Concordia, many have been acting like business will never be the same for Carnival (NYSE: CCL). In my view, this negativity is overblown: consumers tend not to be paranoid and understand that disasters are exceptions to the rules. Day by day, it appears that Carnival will be paying less of a price for the fiasco than originally feared.

As the largest cruise company in the world, Carnival is not going away any time soon. However, what disappoints me is the company’s trajectory: instead of building five ships each year (like it has done over the past 5 years), it will instead build two or three; it's as if the carnival fun has died! Analysts have tried to put an attractive twist on the decline in shipbuilding by arguing that this effort will allow supply to meet demand. More bluntly, it's a decrease of supply to meet sagging demand.

Unfortunately, a reduction in spending will compromise management's focus on penetrating "under-tapped" markets. Equipped with 100 ships and a passenger capacity north of 200,000, investors have hailed the cruise operator for its ability to target a range of diverse markets. Cruises already suffer from low domestic penetration, and while some have argued that this widens upside, my belief is that instability in the Mediterranean (to say nothing of poor consumer confidence) will limit this attraction.

Barbie To Cruise Ahead With Activision

Sorry for that cheesy subheading… In any event, I am attracted to the fundamentals of Mattel (NASDAQ: MAT) and Activision Blizzard (NASDAQ: ATVI). Despite suffering through a period of low consumer income and expenditure, both companies have managed to thrive. 

The toy industry has been surprisingly resilient, and Mattel in particular has generated significant cash to continually boost dividends. A turnaround in Fisher-Price from greater buying at retailers will catalyze the bottom-line, while the inventories are well aligned for the quarters ahead. The toy producer has gained market share domestically and in five European markets. While FX headwinds have led to a 1% decline abroad, gross margins are still up nearly 3.5% year over year. 

In addition, the company is a safe pick. To say nothing about the dividend yield, the downside is highly limited by a top product portfolio that includes well-known toys such as Thomas & Friends, Matchbox, Fisher-Price, Hot Wheels, and, of course, Barbie. Licensed brands like Diego, Batman, and Brave also make the company a leading partner with major media businesses. The one key risk is how Wal-Mart, Toys 'R' Us, and Target represent nearly two-fifths of toy-selling business; this means that if any of these companies were to go under, there would be a disastrous decline in sales. More likely, however, Mattel will gain more top retailers.

Activision similarly has an attractive product portfolio. From World of Warcraft to Skylanders, the video game producer is no stranger to releasing top-selling titles. In my view, Activision is at a compelling price to justify making an investment. .

What attracts me to Activision, as opposed to Nintendo, is that it knows how to create sustainable streams of free cash flow. The company brought you massive multiplayer games and revolutionized the expansion system. We have already seen how successful a subscription model for World of Warcraft was; should we not expect the same for Skylanders?

In addition to developing subscription models, Activision also seems to be taking on the mobile realm. It is partnering with Tencent Studios to develop a mobile strategy for Call of Duty Online. At the same time, free cash flow derived from Call of Duty: Black Ops 2, Skylanders 2.0, and WOW: Mists of Pandaria, among others, should be sufficient to bridge the financing gap. Equipped with a significant amount of content backlog, the company could position itself for record EBIT that will dissipate investor anxieties.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard and Mattel. Motley Fool newsletter services recommend Activision Blizzard and Mattel. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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