What to Look at For Leisure Stocks

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

With the global economy improving, investors should consider backing leisure stocks. In particular, they should base their decisions on earnings growth, free cash flow yield, ROIC, and the long-term fundamentals. If companies are able to deliver solid value for investors and are well positioned to capitalize on consumer trends, they are worthy of a buy. Below, I review 2 stocks with this in mind.

Carnival Corporation (NYSE: CCL): A Mixed Bag

At around 21.5x past earnings and -2.6% annual EPS contraction over the past 5 years, Carnival is not exactly cheap. Free cash flow has climbed to $1.3 billion after breaking even in early 2010, but this is still only a 4.3% yield against the market cap. Moreover, Carnival reported an average return on invested capital of 15% between 1995 and 2005, and this has since come down significantly. The current ROIC is just 4.4%.

The stock is a mixed bag. Let's start with the optimistic points: first, I like its bright outlook on the future. The agreement to build two new cruise ships--one of which will carry a stunning 4,000 passengers--indicates confidence over future demand. In addition, performance has been significantly above expectations. In the most recent quarter, earnings came out 4.8% ahead of consensus and 9 cents above the midpoint guidance. Capacity rose 3% in North America while the European, Australia, and Asian brands rose 2.1%. Management has also taken steps through hedging and improving efficiency to reduce exposure to fuel cost pressures. Furthermore, the share repurchase program still has $265 million left.

But the headwinds outweigh the tailwinds. In addition to poor free cash flow generation and ROIC, costs are generally rising. This is a bad a combination for value creation, which requires ROIC to be meaningfully higher than the weighted average cost of capital. Perhaps most importantly, I believe that investors will transition over to cheaper and better performing peers. Royal Carribbean (NYSE: RCL), for example, trades at lower multiples for faster growth. At 13.2x forward earnings and 0.88x book value, the price is very compelling. Furthermore, it generates excellent free cash flow. In the twelve trailing months ending 3Q12, $792.3 million was generated--this represents a 10.4% yield against the market cap.

And the company has strong growth forecasts. Assuming expectations are met, 2016 EPS will come out to $3.54. At a multiple of 15x, this translates to a future stock value of $53.10. Discounting backwards by 10% yields a present value of around $33. This means the company is around fair value, which is attractive compared to the PV analysis for Carnival. And Argus even called it a $40 stock in its Nov.14 report.

Don't Listen To Bears About China, Buy Wynn Resorts (NASDAQ: WYNN)

If cruise ships are not your preferred market, but you still are looking for leisure stocks, try casinos. Wynn Resorts may trade at a high 20.9x multiple, but it is forecasted for 15.2% annual EPS growth over the next 5 years. It has increased 30.6% from its 52-week high, which it deserves in light of substantially improving FCF over the last 3 years. FCF has gone from around -$803 million in 2008 to around $1.1 billion today, or a 10% yield. ROIC of 9.4% could be better, but the firm is heading in the right trajectory.

I am particularly bullish on the stock, because I find that the market has become too bearish on a Chinese slowdown. Macau casinos brought in $3.5 billion in October alone from the terrific Golden Week--a 27% year over year increase. Moreover, Wynn's YTD momentum in China is about where it was a year ago--obviously much better than what some feared in a September report showing a slip in pace. The special dividend distribution is also coming from domestic cash holdings and thus won't limit investments in Macau. During the first quarter of 2012, EPS  of $1.48 came out 14 cents ahead of expectations.

Furthermore, the fundamentals are heading in the right direction. Room rate data look good, and the global economy is starting to recover. Shareholder value has fallen 10.2% over the last 12 months. I recommend buying on an expected reversal, which is reflected both in operations and the long-term trends.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Royal Caribbean. 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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