Cruise-Ship Stocks Prepare to Set Sail

By Jack Hough 

Cruise stocks jumped this week on news the U.S. will begin to normalize ties with Cuba. Investors are envisioning new routes to the island packed with curious vacationers. But there are bigger reasons to like shares of Carnival and Royal Caribbean Cruises, which could return 15% apiece during the next year.

One is China, which is quickly developing an appetite for shipboard vacationing. Both Carnival and Royal Caribbean have committed ships there, with lucrative results. And both can sell older vessels to Chinese investors, then operate them under contract.

Another reason to like cruise stocks: plunging oil prices, which cut expenses. A third reason is retiring baby boomers in the U.S., who have made cruises one of the fastest-growing parts of the travel market.

Virgin Group, best known for flights and wireless service, announced this month that it will enter the cruise business. It says it wants to disrupt the industry with ships that are "sexy, hip and cool."

Maybe, but new cruise ships can cost close to $1 billion apiece, and Virgin plans to build two, which could take three years. A capital outlay like that calls for more than visions of sexiness.

Meanwhile, the incumbents are making upgrades of their own to lure younger cruisers, adding ship-wide Wi-Fi, family suites and peppier excursions with activities like zip-lining and rock-climbing. Carnival (CCL) and Royal Caribbean (RCL) have both recently turned small revenue increases into rapid earnings gains.

Carnival has baggage. It has yet to recover fully from twin disasters, the deadly sinking of the Costa Concordia off Italy in 2012 and a fire last year aboard the Carnival Triumph, which knocked out power for both propulsion and support systems, including sewage.

Carnival's "net yield," a measure of the revenue it extracts from available berths, increased last quarter after nine quarters of declines. Royal Caribbean, meanwhile, expects net yield to increase next year for the sixth straight year. If Carnival can close the image gap, its shares could soar.

Royal Caribbean is the safer bet, however. With a relatively young and modern fleet, it will be able to dial back spending in coming years. By 2017, free cash could top $2 billion a year. That's more than 11% of the company's market value. Analysts expect the dividend payment to double by then. Royal recently yielded 1.5% and Carnival, 2.3%.

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