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Can Royal Caribbean (RCL) Sail Forward on Strong Guidance?

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On Aug 13, 2014, we issued an updated research report on Royal Caribbean Cruises Ltd. (RCL - Free Report) . This well-known cruise operator posted second-quarter 2014 results on Jul 24 with the bottom line beating the Zacks Consensus Estimate, but the top line missing the same. The bottom line was also better than management’s guidance range of 45–55 cents.

Total revenue in the quarter increased 5.2% year over year to $1.98 billion, due to higher passenger ticket revenues as well as increased onboard spending. However, revenues missed the Zacks Consensus Estimate of $1.99 billion by 0.5% partly due to higher cruise operating expenses.

Net cruise costs (NCC), excluding fuel, decreased 4.7% on a constant currency basis, better than 1.3% increase in the last quarter. NCC was 220 basis points lower than the mid-point of the company’s expected range.

On a constant currency basis, net yields increased 2.6% year over year. This was higher than the company's guidance driven by strong close-in booking trends in European and China sailings despite continued softness in the Caribbean business. Yields were up in double digits in Europe and China which offset the Caribbean's softness.

Moreover, the company has a positive outlook for the coming quarters on solid demand for European, Alaskan and Chinese sailings. Meanwhile, Asian sailings have also exceeded pricing as well as volume expectations. Despite the island dispute between China and Japan, management expects China to account for one-third of its total capacity and generate double-digit yield improvements in 2014 driven by strong booking trends.

Given the second quarter performance and strong booking trends, the company increased its earnings guidance for 2014 and expects it in the range of $3.40 to $3.50 per share. Meanwhile, earnings for the third quarter are expected to be $2.20 per share, much higher than $1.71 reported in the year-ago quarter.

In addition to strong booking trends, the bottom line is expected to be driven by the company’s efforts to improve fuel efficiency and thereby reduce fuel costs. Further, Royal Caribbean uses fuel swaps to mitigate fuel price volatility.

Royal Caribbean is pursuing profitability improvement initiatives aimed at generating long-term cost savings. One of these initiatives that begun in 2013 is associated with restructuring and consolidation of global sales, marketing, general and administrative structure. These initiatives include the consolidation of the majority of the call centers, thereby eliminating 500 shore-side positions and lowering expenses. Moreover, the company is establishing marketing and revenue management teams in fast growing markets. Combined with declining fuel costs, profitability initiatives should reduce overall expenses thereby boosting profitability.

Though the company’s marketing and promotional spending would help the company over the long-term, it would remain the major threat to the company’s margin in the near-term. Additionally, the sluggish macroeconomic environment in Europe remains a concern. Moreover, relations between China and Japan are currently tense over the territorial row involving islands in the East China Sea known as the Senkaku islands in Japan and the Diaoyu islands in China. This conflict would affect the company’s itineraries as well as demand profile.

Royal Caribbean sports a Zacks Rank #1 (Strong Buy). Some other stocks worth considering in the sector include Diamond Resorts International, Inc. , HomeAway, Inc. and International Speedway Corp. (ISCA - Free Report) . All these stocks have a Zacks Rank #2 (Buy).

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