Could Royal Caribbean, Carnival Outperform?

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

Warren Buffett once said that he was a member in handy for AA--not "alcoholics anonymous" but "airplanes anonymous"--when he considers buying shares of an airplane. I feel the same way about cruise lines. While they are fun to be on, they are ultimately a headache for many shareholders. Margins are so low that the break-even is said to be dependent on sales in the ship; tickets do not fully cover the cost. Returns on invested capital are low and multiples are often high. That said, they could technically outperform though growth.

Could Carnival (NYSE: CCL) Outperform?

At only 12x forward earnings, Carnival is trading at a reasonable valuation. Analysts forecast 11.7% annual EPS growth over the next five years. Assuming expectations are met, 2016 EPS will come out to $4.26. At a multiple of 15x, the company would eventually trade at $63.90. This provides 17.7% average annual returns when you factor in dividends and easily warrants making an active investment. Stifel Nicolaus has signaled optimism through recently putting out a $48 price target, which is up $2 from the previous estimate.

Consumers have been increasingly booking cruises closer to the launch date in an effort to get the strongest savings, a trend that has made Carnival more conservative in its outlook. Nomura, however, is encouraging investors to buy off of a strong Wave season. In the company's recent quarterly results released on Dec. 20, revenue and EPS both came in ahead of expectations. This followed a revenue and earnings beat in the preceding quarter. Carnival's management has a history of providing soft guidance with an interest in generating positive "surprises." There is further upside from the company's focus on increasing capacity through the agreement to build two new cruise ships: a 2,600-passenger and a 4,000-passenger that will launch in 2015 and 2016, respectively.

Since the traumatic sinking of the Costa Concordia, the cruise company has struggled with margins in light of weak demand. It is therefore fortunate that the company is guiding for an improvement in cruise ticket prices concomitant with greater booking volume. 10 of 16 reporting analysts, however, are still on the fence with a rating of "hold." This is complicated by poor liquidation (current ratio is 0.25) and no return on invested capital.

Royal Caribbean (NYSE: RCL): A Mixed Bag

You may be tempted to ride Royal Caribbean's wave after seeing its stock bounce 52.9% from the 52-week low. Part of this momentum comes from a more optimistic outlook. It gained 9.1% in value after the company boosted its full year earnings forecast off of an improved ability to increase prices. At a respective 16.5x and 12.5x past and forward earnings, however, the stock looks reasonably priced. Analysts forecast 9.9% annual EPS growth over the next five years.

Assuming expectations are met, 2016 EPS will come out to $3.56. At a multiple of 16x, this translates to a future stock value of $57 for 15.4% average annual returns when you factor in dividends. Discounting backwards by 10% yields a present value that is more or less in-line with the current market assessment.

There are several factors to consider before investing in Royal Caribbean. Though the stock has missed expectations despite improving its tone on booking volumes, Royal Caribbean's 20% increase in the dividend distribution in mid-September showcased confidence in the underlying fundamentals. I further like the company's interest in increasing the numbers of cruises coming out of and to China. This emerging market faces a sharp growth curve and will benefit from increasingly liberalized trade, which drives tourism. If Royal Caribbean can establish an early-mover advantage in this market, it is a solid check in the "plus" column for long-term catalyst drivers. Analysts are anticipating Chinese tourism sales to increase 14% annually over one decade. So, it's largely a mixed bag for this cruise company.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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