James Barrow, executive director of Dallas-based investment firm Barrow, Hanley, Mewhinney & Strauss, is the lead portfolio manager for the Vanguard Windsor II (MUTF:VWNFX) and Vanguard Selected Value (MUTF:VASVX) funds. Two of his top holdings are Carnival Cruise Lines (NYSE:CCL) and Royal Caribbean Cruises (NYSE:RCL).
Of the two, Carnival is the much bigger company with double the annual revenue. But while Barrow obviously believes in both companies, here’s some reasons why he should sell Carnival and buy Royal Caribbean instead.
Top Holding
While the Windsor II Fund holds $299 million in Carnival stock, it’s not one of its top 10 holdings as of the end of October. On the other hand, Royal Caribbean is the No. 1 holding of the Selected Value Fund at $99 million. Portfolio managers often talk about investing in their best ideas. If that’s in fact the case, RCL represents 2.48% of the total Selected Value portfolio compared to CCL’s 0.88% for the Windsor II fund.
It’s somewhat like comparing apples to oranges because the Windsor II is a large-cap fund and the Selected Value invests in mid-caps, but at least by this standard, the well-regarded manager himself would seem to view Royal Caribbean as the better idea.
China
Royal Caribbean and Carnival are building important businesses in China. RCL is the top cruise line in China, with CCL and its Costa brand a close second. However, this might change for two reasons.
First, Royal Caribbean announced in June that it would move Voyager of the Seas to Shanghai starting in June 2012. Until now, the 3,100-passenger ship spent winters in the Caribbean and summers in Europe. The ship will join the Legend of the Seas, which is ready to commence its fourth season in China in early March. With two ships in the region, including the largest in the Voyager of the Seas, RCL is ready to take China by storm.
That brings us to the second reason, which is Royal Caribbean’s strategic relationship with the Xiamen municipal government and China World Cruises. CWC is a wholly owned subsidiary of Beijing-based theme park developer Shan-Hai-Shu and plans to spend $5 billion developing the Xiamen waterfront, including a four-berth cruise terminal. With cruises leaving from Chinese ports up 18.8% year-over-year from 2010, Royal Caribbean is out in front of the pack and ideally positioned to benefit from this growth.
Financial Comparisons
On the surface, Carnival appears to have the stronger balance sheet, with debt-to-equity of just 40% compared to 104% for Royal Caribbean. However, several things stand out from their most recent quarterly reports.
For instance, Royal Caribbean’s current ratio is double Carnival’s, and its cash-to-assets ratio is 2.2% — 120 basis points higher than its bigger rival. On the revenue front, Carnival increased sales 11.7% compared to 12.7% for Royal Caribbean, and in terms of operating income, RCL’s increased 13.9% versus an increase of just 2.2% for CCL. A main reason for the difference is the fact Carnival’s fuel costs jumped 46.7% year-over-year to 11.5% of revenue, while Royal Caribbean’s increased 22.9% year-over-year to just 8.7% of sales.
Some of the differential could be because of the difference in month-end of their respective quarters (August for Carnival, September for Royal Caribbean), but I doubt 24% worth. Although Carnival’s operating margins are higher than Royal Caribbean’s, if fuel costs continue to rise as fast as they did in the third quarter, they won’t be for much longer.
Bottom Line
Both companies have struggled to take profits to the next level. With a PEG ratio half Carnival’s — and most other valuation metrics are better, for that matter — RCL stock is simply a better value than CCL.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned stocks.
