Investors seem to have cooled on Carnival Corporation (NYSE:CCL) after an improbable series of catastrophic failures on its cruise ships. Although the deadly Costa Concordia incident took the greatest toll on passengers, the company’s multiple breakdowns in the Gulf of Mexico likely caused a greater backlash among potential customers.
The result of having nothing but bad news come out about the company was a weak first quarter for bookings, the largest booking quarter of the year. As a result, management lowered its guidance for the year and investors lowered the price they are willing to pay for the stock. This presents an opportunity for long-term investors to get in at an attractive price.
Durable franchise
Although bad publicity has had a short-term impact on bookings, it is unlikely that the company’s long-term prospects have been tarnished in any meaningful way. Carnival is simply too dominant to be toppled.
Its closest competitor, Royal Caribbean Cruises Ltd. (NYSE:RCL), is only half the size of Carnival Corporation (NYSE:CCL). The third-largest cruise operator, Norwegian Cruise Line Holdings Ltd (NASDAQ:NCLH), is less than half the size of Royal Caribbean.
As a result of having superior economies of scale, Carnival earns significantly higher margins than its peers.
Since economies of scale are the most important competitive advantage in the cruise industry, it is unlikely that Royal Caribbean or Norwegian Cruise Line Holdings Ltd (NASDAQ:NCLH) pose a significant threat to Carnival’s market dominance. If either company starts taking market share, Carnival can simply reduce its prices to a point where the smaller competitor is unable to generate a profit.
Although this would reduce Carnival Corporation (NYSE:CCL)’s earnings, it would be more devastating for the smaller competitor. As a result, Royal Caribbean Cruises Ltd. (NYSE:RCL) and Norwegian only engage in price competition in markets in which they have superior scale. This allows each company to consistently turn a profit.
Investment case
Carnival Corporation (NYSE:CCL)’s weak booking season proves that brand image is a relevant factor in cruise selection, but available routes and cost of journey remain the most important factors for customers. Fortunately for shareholders, Carnival has more than double the cruise ships of its nearest competitors — which affords it greater capacity on popular routes — and the widest base across which it can spread its fixed costs — allowing it to offer competitive prices while earning higher margins than its competitors.
In other words, Carnival Corporation (NYSE:CCL) still earns top marks on the two most important factors in cruise selection, despite the short-term setback that comes as a result of an unprecedented string of bad publicity for the company.
Carnival’s size advantage allows it to earn high return on equity relative to its peers; over the last decade the company has generated a 10% return on equity, compared to 8% for Royal Caribbean and about 0% for Norwegian Cruise Line.
More impressively, Carnival has achieved its higher return on equity while using less debt than its peers. In fact, Norwegian Cruise Line is the highest-levered of all three, though its operational volatility makes it the least likely to gracefully handle a heavy debt burden.
Carnival currently trades at 1.2 times book value. If the company continues to earn a 10% average return on equity, investors will receive an 8.3% annual return on investment. However, if the company increases its debt load and maintains current earning power, investors will easily earn a mid-double-digit annualized return on investment.
Bottom line
Carnival Corporation (NYSE:CCL) is the perfect example of short-term worries providing an opportunity for long-term investors to make a great investment. Investors who use reason and logic to make their decisions will be able to ignore the negativity surrounding Carnival and realize that a great investment opportunity awaits them.
Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Ted is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Don’t Let Bad Headlines Scare You Away From This Stock originally appeared on Fool.com and is written by Ted Cooper.
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