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Royal Caribbean Cruises: Smoother Sailing Ahead

Investor fears have rained on cruise-line stocks, but clouds have cleared, and the long-term voyage looks promising.

That investors have been pessimistic toward cruise-line stocks should come as no surprise. After all, two of the biggest enemies of cruise operators -- rising fuel prices and hurricanes -- have been weighing on investors' minds for some time. Year to date as of December 21, shares of Carnival and Royal Caribbean, the two largest cruise lines, were down 8% and 7%, respectively. Yet, oil prices are well-below their summer highs, the recently concluded hurricane season turned out to be unusually benign, and both Carnival and Royal Caribbean beat earnings estimates in their most recently reported quarters.

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Analysts see smoother sailing for the cruise industry over the horizon. "Favorable demographics, notably an aging population, provide a nice tailwind," says Morningstar analyst Sumit Desai. Lower fuel consumption, bigger ships and expansion in Europe will boost revenues and profits at cruise lines for years to comes, says Michael Savner, a Banc of America Securities analyst, who rates the stocks of both Carnival (symbol CCL) and Royal Caribbean (RCL) as buys.

For cruise lines, size matters. About one in four cruisers travel with Royal Caribbean. It is second only to Carnival, which has about 60% of the market. Big cruise companies can spread the costs of labor, supplies, docking and fuel over their large fleets. This helps Carnival and Royal Caribbean defend their business against smaller outfits.

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The bigger-is-better rule applies to ship size as well. Royal Caribbean operates 34 cruise ships, including Freedom of the Seas, which carries 3,634 guests and is the largest cruise ship in the world. The Liberia-based company will launch two other ships as large as Freedom of the Seas, one in May 2007 and another in 2008. Royal Caribbean has four other ships under construction. By 2009, it expects to introduce a massive cruise ship that will hold 5,400 passengers.

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Carnival's latest quarterly earnings report, issued December 21, blew past estimates. The company announced quarterly earnings of 51 cents per share, beating the average of analyst estimates by 4 cents. Carnival shares rose 2%, to $49.06, on December 21. Royal Caribbean shares did even better, gaining 3% to close at $41.07. Strong performance in Europe and the addition of three new ships buoyed Carnival's earnings. In November, Royal Caribbean reported a third-quarter profit of $1.63 per share. That also beat analyst estimates by 4 cents a share. The company credited a calm hurricane season and lower fuel prices for the improvement.

Between the two stocks, Royal Caribbean is more attractively priced, Savner says. Royal Caribbean shares trade at 13 times the $3.12 per share that analysts expect the company to earn in 2007, while Carnival stock trades at 16 times expected earnings of $3.05 per share for the year ending November 2007.

Investors in cruise lines have to contend with unusual risks. Royal Caribbean had to dock Freedom of the Seas on December 10 for a two-day mandatory scrubbing recommended by the Centers for Disease Control and Prevention after an onboard virus outbreak. The company paid passengers for the delayed boarding and damages caused the outbreak. Royal Caribbean estimates that the delay and refunds will hurt fourth-quarter earnings by 3 cents per share.

Cruise-line stocks seldom give investors a steady ride. A spike in fuel prices or severe weather or a weird viral outbreak can hit shares hard in the short-term. But analysts forecast long-term earnings growth of 12% a year for Royal Caribbean. Not a bad voyage if your stomach is strong enough to withstand occasionally choppy waters.

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