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Carnival or Royal Caribbean: Which is a Better Cruise Stock?

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Per the 2018 outlook by Cruise Lines International Association (CLIA), the cruise industry is steadily treading on a growth trajectory, with 27.2 million passengers expected to set sail in 2018. In 2017, approximately 25.8 million passengers cruised compared with 24.7 million in 2016. The upside in demand for cruises is largely backed by a favorable economy, exhibiting increased consumer demand for goods and services.

According to the Fed’s latest forecast, the economy will grow at a reasonable rate of 2.7% in 2018. Moreover, high real disposable income and low inflation are resulting in higher purchasing behavior. Additionally, a strong economy and increased consumer confidence have driven demand for both leisure and business travel.

In line with the industry’s growth, leading U.S. cruise companies — Carnival Corporation (CCL - Free Report) and Royal Caribbean Cruises Ltd. (RCL - Free Report) — are trying out different strategies to rake in profits. The companies are also leaving no stone unturned to cash in on the profitable opportunities that the current industry holds.

With both the companies carrying a Zacks Rank #3 (Hold), let’s find out which one is placed better with respect to other parameters.

Price Performance and Valuation

While the Zacks Leisure and Recreation Services Industry has grown 1.1% so far this year, Royal Caribbean has lost 1.1%. Carnival’s gain of 1.4% has surpassed the industry.

Meanwhile, a look at the EV/EBIT ratio shows that the valuation of the companies looks stretched. The most suitable ratio to evaluate these cruise lines is EV/EBIT. This ratio is also preferred over EBITDA because of the wide difference in the companies’ asset financing patterns.

For the industry as a whole, the EV/EBIT ratio stands at 12.43, slightly undervalued than the S&P 500’s value of 15x. The cruise lines are overvalued compared with the broader industry. However, here Carnival has an edge with a lower EV/EBIT value of 14.1 compared with Royal Caribbean’s figure of 18.2x.

Earnings History and Projected Growth

Both Royal Caribbean and Carnival have beaten earnings estimates in each of the last four quarters. While Royal Caribbean has an average positive earnings surprise of 7.34%, Carnival’s average is 15.42%. For the current year, Royal Caribbean’s earnings are expected to grow 17.9%, higher than Carnival’s projected EPS growth of 14.9%.

Debt Ratio

Since the sector has high financial leverage, the debt-to-asset ratio comes into the picture. This measures the ability of a company to service long-term debt. Hospitality stocks should ideally have lower debt ratios, implying a higher proportion of the company’s assets over the long term. Here, Carnival is at an advantage with a debt ratio of 23.1% compared with Royal Caribbean’s 36.8%. The industry average for the same is 28.3%.

Net Margin

Traditionally, gross margin for the cruise companies is comparatively higher, as majority of the expenses comes from the cost of operations and not cost of goods sold. However, the sector’s profits are not very high, which is best captured by net profit margin or net margin.

The industry’s trailing 12-month net margin is 10.3, while that of Carnival and Royal Caribbean is 14.7% and 18.5%, respectively. It is to be noted that Royal Caribbean’s profit-driving initiatives have helped it in driving margins higher than Carnival.

Our Take

Our comparative analysis shows that although Carnival has an edge over Royal Caribbean in terms of share price appreciation and valuation, the higher projected EPS growth puts Royal Caribbean in the lead. Also, in terms of margins, Royal Caribbean has clearly outperformed Carnival.

Stocks to Consider

Two better-ranked stocks in the industry are Lindblad Expeditions (LIND - Free Report) and Six Flags Entertainment (SIX - Free Report) , each sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

While Lindblad Expeditions’ current year earnings are expected to grow 155.6%, Six Flags Entertainment’s 2018 EPS is projected to improve 33.8%.

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