), at $43, achieved the fair value level I expected when I
recommended purchase in March of this year at $30. (See
Royal Caribbean: A Buy in Carnival's Wake
). However, some of my worries are coming to the fore, and I
believe that it would be a good time to take profits.
My original recommendation was based on a slow-growth economy,
specifically 2-3% economic growth at most, and not a full economic
recovery from the recession. I also expected cruise industry
expenditures to grow at 3-5% at most. And there has been no
evidence since then to believe otherwise. After
) problems, I expected that there would be a market share gain by
RCL. Now, based on only one or two quarters of data seen, I believe
that has been happening.
But the possible events and changes I named in my caveats are also
now a reality. There has been some some weakness in the consumer
sector, for example, especially in clothing and auto parts, among
I also said, "Nobody seems to be talking yet about the increased
spending for health care that seniors will do because of
Obamacare-related cutbacks. I have not come to grips with that yet,
and it will not unfold for maybe two to three years, well after
this stock will have 'worked,' if it is going to."
I believe all of the hubbub over the Affordable Care Act site
debacle will concentrate the thoughts of American consumers on the
eventual financial fallout from Obamacare. That shift could hurt
the stock market overall, but I think that it will have the most
impact on cruise customers, who are a fairly conservative,
unadventurous group. Retirees will not have problems with Medicare
initially, but I believe that they will reduce their spending when
they see what's coming. The core crowd (age 45-65) will, I believe,
cut back as they see or become the victim of
. Premiums will increase, of course, and in the shorter term, must
come out of discretionary spending.
At 3.6%, the expected compound average growth rate in capacity for
the next five years is still higher than I would like to see. While
that figure is a big decline from the growth rate of past years, it
is still higher than a reasonable expectation for weighted average
GDP growth of the North American plus European Economic Community.
In other words, overcapacity is still getting worse.
My present valuation, with Royal's attainment of a deserved 6.5%
risk discount, is fair. I use consensus EPS estimates of $2.31 and
$3.06 for 2013 and 2014 respectively. But I do not use the $3.84
for 2015, because these estimates have an acceleration in revenue
growth from 5%-ish in 2014 to 9-10%, which includes high margined
onboard revenue, which I think is unwarranted. Using a $3.54 for
2015, I put together two next-12-months earnings-per-share
estimates of $2.66 and then $3.24. Using a 4.2% risk-free rate
(3.6% long Treasury plus 60bps to counter quantitative easing), my
model says that the stock at $43 is discounting an 8% five-year
growth rate, which is maybe 1-2% higher than what I might expect.
One more consideration, albeit one for the future: I am beginning
to wonder if the industry is on a bit of a treadmill as newer,
bigger ships are added to the fleets. I realize that they are more
profitable from a margin standpoint, but I wonder whether part of
their margin increase comes from customer demand, as they are
willing to pay a premium for the biggest and latest. What would
happen to margins if capacity growth grew at zero? Profitability
would obviously go up, but I wonder if enough passengers currently
going out on the biggest ships would choose to go elsewhere, so
that the leverage would not be up to expectations.
I have also had other non-economic concerns about the largest
ships. As I was writing this I noticed a
New York Times
article from October 27, 2013 entitled "
Too Big to Sail? Cruise Ships Face Scrutiny
" by Jad Mouawad. It is interesting reading, though it will not
affect an investment in a cruise line -- until it does.