The cruise industry, along with the broader travel sector, has enjoyed a remarkable boost in demand, occupancy levels and ticket prices over the past year. Indeed, with more families and baby-boomers becoming advocates of shuffle board games and fine dining at the captain’s table, the bulls argue that cruise liners are a sure-fire bet. The truth, however, isn’t quite as sunny as they would have us believe.
Firstly, this is a notoriously cyclical business as most households still treat sailing around the Med or the Caribbean as an expensive luxury. That makes it vulnerable in a climate of government spending cuts, rising unemployment and tax hikes. And the incomes of many retired punters (the target market for many cruises) have been rocked by record low interest rates. Worse, though, are the industry’s high fixed costs. In the event of a slump – which I expect to occur from mid-2011 onwards – operators will be forced to fill their empty cabins using heavy discounting. For example, in 2009, although passenger numbers rose, prices had to be slashed. Yields or revenue per berth per day fell 15% and margins dived.
So what of Carnival, the world’s largest operator, boasting a 45% slice of the market? It owns 97 vessels (with another 11 on order) across 11 brands. These include Cunard and P&O, with a total capacity for 185,000 passengers.
Turkey of the week: Carnival (LSE: CCL), rated a BUY by Raymond James
Earnings came in ahead of City estimates, with the group saying that ticket prices and forward sales remain strong. Indeed, CEO Micky Arison even raised his earnings per share (eps) target for the year ending November 2010 to between $2.48 and $2.52. This is encouraging, but to me it doesn’t justify the stock’s racy valuation.
Investors should remember that reservations are a lagging indicator – most travellers book their holidays six months in advance. And although 2010 has been buoyant, I suspect the seas will become far stormier in 2011 as passengers pay less for their berths and spend less on board.
Worse, due to the four-year lead time required to build a ship, Carnival is still committed to expand its fleet 13% by 2011. Adding capacity during a downtime can be tantamount to commercial suicide. Lastly, there are also the usual challenges of managing foreign-exchange fluctuations, health scares, terrorism, and volatile fuel costs.
So what are the shares worth? It is important to strip out the distortive effects of the $8.7bn debt load, the depreciation charge relating to the ships, plus the ups and downs of the industry. I would rate the stock on a through-cycle earnings before interest, tax, depreciation and amortisation multiple of eight That delivers an intrinsic worth of about £18.10 per share, or 30% below today’s price.
Given all this, together with Carnival’s exposure to cash-strapped Americans (two-thirds of tickets sold are for US departures), this is one port to avoid.
Recommendation: SELL at £26.12
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments