According to a projection from trade group Cruise Lines International Association, more than 25 million will take to the seas using cruise ships this year. As of Dec 2016, 26 new ships had been, of which ocean vessels amounted to $6.8 billion. A majority of travel agents expect cruise sales to increase this year. During 2005-15, the demand for cruises experienced a 62% jump.

Industry insiders expect the demand for cruise ships to remain strong this year. Their attractive pricing versus land based trips and their wide ranging appeal are other factors which give them an advantage. As investments, they stand out for their comparatively reasonable valuations and long-term potential. These are the investments you would buy and hold for extended periods for solid returns. 

Stocks Under Consideration

The two leading U.S. listed cruise lines, Carnival Corporation (CCL - Free Report) and Royal Caribbean Cruises Ltd. (RCL - Free Report) are the ones you would probably be considering if you’re looking to invest in the vacations segment. With summer holidays around the corner, this is the best time to determine which of these is a better stock.While Carnival has a Zacks Rank #3 (Hold), Royal Caribbean Cruises carries a Zacks Rank #2 (Buy). 

Other major operators in the cruise segment include Norwegian Cruise Line Holdings Ltd. (NCLH - Free Report) and Disney (DIS - Free Report) . The entertainment behemoth has a small but impressive line of ships and a private island in the Bahamas for stopovers to boot.

Price Performance

The Zacks Leisure And Recreation Services industry has posted a stellar performance over the last year, gaining a substantial 24%. Both Royal Caribbean and Carnival have outperformed the broader industry. But the smaller of the two stands out with a return of 45.8% while Carnival has gained 34.9% over the last year.

Valuation

The most appropriate ratio to evaluate these two cruise lines is EV/EBITA. This metric is commonly used for several media sub groups as well as chemicals, gaming, bus and rail industries. This metric is preferred when it becomes inappropriate to use EBITDA because of wide differences between the two companies’ asset financing patterns. This refers to the mix of ownership, rentals and leases.

First, it is important to consider where the industry as a whole stands from a valuation perspective. Here, we can see that with an EV/EBITDA of 14.32, the entire leisure and recreation services industry is marginally undervalued compared to the S&P 500, which has a value of 14.6.

Coming to the two cruise lines, both Carnival and Royal Caribbean are overvalued relative to their broader industry. However, Carnival holds the edge here with a lower EV/EBITDA value of 17, compared to Royal Caribbean’s value of 20.53.

Net Margin

Traditionally, the gross margin for companies within the hospitality industry is comparatively higher. This is because for most companies within hospitality industry, the bulk of costs emanate from cost of operations and not cost of goods sold.

However, profits are not very high within the sector, a phenomenon best captured by net profit margin or net margin. This is because the operating costs for the industry are much higher when compared to other sectors. Industry comparisons are, therefore, necessary to ensure that performance is at an optimal level.

Both Carnival and Royal Caribbean outperform the industry, which has a net margin TTM of 13.13. However, Royal Caribbean outperforms Carnival, since its net margin TTM is higher at 16.37%, compared to its larger peer’s level of 15.47.

Debt Ratio

The hospitality industry is characterized by a high level of long term debt as well as current liabilities. Such high levels of debt are required to finance, maintain and operate large cruise lines as well. Given the high proportion of long term assets, debt financing over an extended period is a necessary requirement.

Since the sector has a high level of financial leverage, debt ratios naturally come into the picture. This measures the ability of a company to services long term debt. Hospitality stocks should ideally have lower debt ratios. This implies that assets are present in higher proportion compared to debt over the long term.

Here Royal Caribbean is at a disadvantage with a debt ratio of 38.92%, which is significantly higher than the industry average of 29.88%. At 23.49%, Carnival has a debt component which is lower than both Royal Caribbean’s as well as the industry.

Earnings History, ESP and Estimate Revisions

Considering a more comprehensive earnings history, both Royal Caribbean and Carnival have delivered earnings surprises over each of the prior four quarters. While Royal Caribbean has an average earnings surprise of 4.6%, Carnival stands out with an average earnings surprise of 12.8%. When considering Earnings ESP, there is nothing to choose from between the two stocks since both their ESP values stand at zero.

Conclusion

Our comparative analysis shows that Carnival holds an edge over Royal Caribbean when considering EV/EBITA ratios and debt ratios. However, when considering price performance and net margin, Royal Caribbean is clearly a better stock. With a Zacks Rank #2 and a higher projected EPS growth for the year at 21.5% compared to Carnival’s value of 14%, Royal Caribbean is clearly the better of the two cruise stocks.