What a difference a year makes.
Last January, the cruise line industry was shaken after Carnival’s (NYSE:CCL) Costa Concordia ran aground off the coast of Italy, killing 32 passengers and crew and triggering a maelstrom of controversy over the industry’s safety practices. Share prices plummeted not only at Carnival, but at rival Royal Caribbean (NYSE:RCL) and others under the weight of lower sales and cancelled bookings during the industry’s all-important “wave season” when most cruises are booked.
However, fast forward to last Friday, when Norwegian Cruise Line (NASDAQ:NCLH) shares soared by more than 30% in an IPO that raised $447 million. RCL and CCL have recovered the ground they lost and more. Bookings have rebounded, and most operators are steering clear of the hefty discounts and sweet promotions that characterized the early 2012 market. This year, the worldwide cruise market is estimated to reach $36.2 billion, up 4.8% year-over-year, according to Cruise Market Watch’s 2013 forecast. That includes expectations of a whopping 20.9 million cruise passengers, or 3.3% more than 2012.
As is the case with all consumer cyclicals, though, cruise lines are vulnerable to economic fits and starts — and European woes show few signs of ending anytime soon. So, let’s break down the prospects of the top three cruise line stocks to see which, if any, look fit to board:
Norwegian Cruise Line: C+
Although NCLH initially considered pricing its IPO in the $16 to $18 range, it settled on $19 a share for last Friday’s debut. The stock soared out of the gate and was trading over $26 late Tuesday. Prior to the IPO, Apollo Global Management (NYSE:APO) and TPG Viking jointly held a 50% stake in the company; Hong Kong-based Genting HK owned the other half.
Fair Winds: NCLH stands to gain market share with a couple of innovations — “freestyle cruising” and “whale” rewards for high rollers at Las Vegas casinos. Freestyle cruising seeks to draw an audience that prefers a less rigid, itinerary-focused cruise. The cruises boast casual attire and no timed seatings for meals. In an expansion of its “Casino at Sea” program, NCLH also has cut marketing deals with some casinos to reward high rollers with discounts on cruises.
Headwinds: The IPO accounted for only about 12% of the company and I wouldn’t be surprised to see Apollo, TPG or Genting sell off some of their stake in the next couple of months. Norwegian still has monster debt of $2.9 billion and ordered a new 700 million-euro Breakaway Plus vessel for delivery in October 2015 — that’s in addition to the Norwegian Breakaway and Norwegian Getaway set for delivery in April 2013 and January 2014, respectively.
Bottom Line: While I’m impressed by the IPO and like NCLH’s “freestyle” niche, I’m not comfortable with the current debt load. Additionally, market conditions can change radically between when a ship is ordered and when it is delivered. Kudos if you got in on the IPO, but I’d wait until the stock proves its sea legs before going all in.
Although CCL shares plummeted more than 13% in the days following the Costa Concordia disaster, by June the company had righted the metaphorical ship. The accident sparked an industry-wide safety push and initiated 10 new safety procedures. These include excess life jackets and a requirement that cruise ships hold emergency “muster” drills before ships leave port.
Fair Winds: CCL is now trading around $38 — up 32% over its one-year low on Feb. 27, 2012, and 10% higher than pre-crash levels. Aggressive brand management and a strong push for cost-efficiency helped mitigate the disaster’s financial impact — although 2012 earnings of $1.3 billion were lower than the peak recession year of 2009. Financial management is perhaps the strongest positive for CCL, which last week re-established a $1 billion share repurchase program and continued its 25-cent quarterly dividend, which yields 2.6% at current prices.
Headwinds: Expect CCL to struggle for a while in the disaster’s aftermath. Chairman and CEO Micky Arison noted in the company’s most recent earnings call that the Costa brand’s recovery would take “multiple years.” Bookings and rates — particularly on the Costa brand — still are lower than normal. Additionally, Carnival faces civil lawsuits from Concordia survivors and family members that will start hitting the courts mid-year. Carnival — which reportedly has said in court documents that “passengers’ negligent or careless behavior were among the causes, if not the only cause, of the alleged injuries and damages” — could risk an even bigger PR mess as the cases proceed.
Bottom Line: There’s a lot to like about Carnival’s fundamentals and financial management, but the company is not out of the woods on the Costa Concordia disaster yet. A lot of things can go wrong in the fickle world of PR and brand management — not to mention the blow to its reputation if the nearly half-billion-dollar salvage operation results in environmental damage. If you’re in CCL, hold, but keep a close eye on the courts and the seas off Tuscany.
Royal Caribbean: B-
Like its industry peers, RCL shares took a hit from the Costa Concordia disaster in the first half of 2012 — but they came roaring back with a vengeance in the second half of the year. The stock has surged 64% since its 52-week low on June 4.
Fair Winds: RCL has been able to benefit from Carnival’s PR hit over the accident. Although troubled European economies pushed earnings and revenue below last year’s numbers, the cruise line’s third-quarter results beat the Street on both the top and bottom lines. The company is aggressively working to hold down costs and as of October, 2013 bookings were experiencing brisk sales. Royal Caribbean also is reducing capacity in the European market by 10%, while adding capacity elsewhere — particularly in Asia/Pacific.
Headwinds: Europe — particularly southern Europe — remains a challenge heading into 2013, and RCL took a hit on Asia last fall due to the territorial dispute between China and Japan. RCL, which hit a new 52-week high last week, has borrowed heavily in recent years to fund new ships; its $7.8 billion in debt remains a concern. Royal Caribbean in December ordered a third Oasis class vessel scheduled to be delivered in mid-2018. The first two ships in the class cost $1.4 billion each.
Bottom Line: All things considered, I think RCL is the best play in this sector right now — if fuel prices remain low and the economy doesn’t go south in a big way. The new expansion of RCL’s distribution deal with Sabre will make it easier for travel agents in Mexico to access the cruise line’s inventory across its brands. If the company’s earnings report (due Jan. 31) confirms stronger bookings and improved on-board revenue, RCL could be positioned to broaden its horizons in 2013.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.