Have Cruise Lines Weathered the Storm?


By Amy Tsao Reports on Sept. 2 that several hundred travelers on a two-week North Atlantic cruise caught the flu-like Norwalk virus aboard the Regal Princess, a Carnival-owned ship, didn't put a drag on the upward momentum of the outfit's stock. Shares in the world's largest operator of recreational vessels actually finished the week up about 2%, as did those of its main competitor, Royal Caribbean Cruises. That came as a relief to cruise operators, which have been dogged by bad luck over the past year. As the economy has struggled to gain momentum, the industry has been hurt -- though not as badly as hotels or airlines, many of which suffered brutal losses that began with the post-September 11 travel malaise.

With the main fighting in Iraq over, the last few months have seen the beginnings of a cruise-industry comeback. Cruise-related viral outbreaks appeared to peak last fall, the latest news notwithstanding. As of the market's close on Sept. 10, Carnival (CCL) was up 37% year-to-date, to $33.45, while Royal Caribbean (RCL) had risen 80%, to $29.43, in the same period. Meanwhile, the stocks of outfits selling recreational products and services gained just 14%.

BOOMERS AT SEA. If cruise lines are to stay on their upward course, it will require an economy strong enough to support price hikes. So far, leisure travelers have indeed come back faster than their business counterparts, but cruise prices "remain generally below levels seen post-September 11," writes A.G. Edwards analyst Tim Conder in an August survey of industry pricing and bookings. (Conder doesn't own the stocks and his firm has no banking relationship with either company.)

Some analysts increasingly wonder how much growth is left, and whether demand can keep up with the increasing number of cruises. Even Ryan Beck analyst Cleo Murphy, who sees the near-term earnings outlook improving substantially in 2004, vs. 2003's relatively lackluster showing, concedes that the ability to raise prices remains an open question in the longer term. Wall Street analysts, on average, expect fiscal 2004 earnings per share to rise 26%, to $2, for Carnival on revenues of $8.7 billion, with a 30% rise, to $2.02, at Royal Caribbean on revenues of $4.1 billion.

Many travel experts regard cruises as some of the best vacation values around, predicting that increasing numbers of aging baby boomers will jump onboard in coming years. The Cruise Lines International Assn. (CLIA), an industry trade group, figures cruises still make up just a small fraction of the leisure-travel market, despite the fact that passenger numbers have risen more than 8% each year for two decades.

BALANCING ACT. Consolidation over the last several years has left Royal Caribbean and Carnival as the industry's dominant leaders. But Carnival CEO Mickey Arison told analysts in July that though bookings have kept up with capacity, pricing, though beginning to improve, remains weak. A.G. Edwards' Conder figures prices likely hit a floor in April or May. Getting prices up from their depressed levels will be a gradual process, analysts agree, given that the economy has been gaining strength more slowly than many would like.

Added capacity in the next couple of years also will exert pressure on prices as new ships, ordered when times were better, start to coming into service. By the end of 2004, capacity will be around 20% above 2002 levels. Murphy estimates the industry can sustain a growth rate of 6% to 8% in capacity without cutting prices.

That means pricing power looks weak until 2005, when the increase in the number of cabins should start to fall behind that for passenger growth, if the industry's long-term growth trend for continues to hold. Capacity, she says, "has been the overriding issue." (Murphy does not own shares and her firm has not provided investment banking for either company.)

It's a balancing act: The industry needs to spark growth without oversupplying the market. In the last few years, operators have done well by adding fresh ports of embarkation -- Boston, for example -- thus saving passengers the cost and hassle of flying to traditional departure points in places like Florida and the Caribbean. Carnival also has designs on Europe, says Murphy, who adds that Continental travelers have long been difficult to win. "Growing international markets is a challenge," she says, "but it also presents one of most important avenues" for growth.

TITANIC DEBT. Some analysts are more sanguine about the industry's prospects. The time between booking and actual travel is getting longer, which assures cruise operators that growth will continue and also solidifies longer-term expectations of steady revenues. And Monica Vatali, an analyst at Shaker Investments, believes the fact that fewer new ships will be under construction once the current batch is delivered also will help pricing power.

"We're still early on in an [economic] recovery," Vatali says. She predicts strong growth for both cruise lines in the next several years, but favors Royal Caribbean. (Shaker owns shares in Royal Caribbean, but not Carnival.) "We think Royal Caribbean can grow earnings 20% annually for the next five years or so," Vatali says. Its valuation of 15 times 2004 consensus earnings is "nowhere close to that [growth rate]," she adds.

Still, any upset to the economy's rebound would worry this industry, says Chris Jarvis, associate director of research at Advest, who notes: "Consumers remain leveraged and [employment] numbers look weak at best." The travel industry, cruises included, could face another setback if worries over the economy become too much of a dark cloud, he says. (Jarvis does not personally own shares in either company, though Advest's private clients do.)

The sector's fortunes remain firmly hitched to the broader economy, and for now, the outlook is bright. Still, for cruise stocks to continue the strong rally they have demonstrated, the players must find ways to get passengers paying more for their trips. And that could be tricky. Tsao covers financial markets for BusinessWeek Online in New York


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