Sunday, July 31, 2011

RCL 2Q Review

Royal Caribbean reported 2Q results Wednesday after the close. EPS for the quarter was $0.43, in-line with street expectations of $0.42 & below our estimates of $0.54. Earnings this quarter were overshadowed by two salient points: an internal accounting error regarding interest expense & an underperformance in the Eastern Mediterranean segment as a direct result of the geopolitical events in Libya & Greece. As a result, management decreased full-year guidance by $0.10 (or $0.20 including the accounting change) to $2.85-$2.95 from $3.05-$3.15.

Excluding the one-time revision related to interest expense, EPS for the quarter was $0.47 & above street expectations & management guidance of $0.40-$0.45. Key metrics, including cash flows, operating income, net yields & net cruise costs were not impacted by the accounting error. While management cited that the error was both internal & embarrassing, we do not believe that the issue is material. The internal accounting staff was incorrectly marking the amortization of undisclosed assets & the law firm Bronstein, Gewirtz & Grossman is currently investigating the issue.

Growth in net yields for the quarter, reported to be +3.8%, were lower versus our modeled +7.0% due to the lagging East Mediterranean segment. Excluding Mediterranean sailings, yields were 9.8%, which we believe show’s strength in the company’s underlying business. Demand across all regions (excluding the Mediterranean) remains strong & management stated that their ability to leverage pricing power remains intact. The company decreased net yield guidance for full-year 2011 to 5% from the prior range of 5%-7%, citing continued uncertainty in the Middle East/Europe & the resulting deterioration in demand. We would like to note that itineraries in the troubled regions account for approximately 13% of RCL’s business.

The stock was hit hard after the release, falling over 13% on Thursday. While the accounting error may affect the short-term credibility of management, it was likely the downward revision to year-end guidance that caused the sell-off. The unfortunate events in the Middle East & Europe have turned what was expected to be an above-average year into a mediocre one. Management remains positive & our bullish thesis on both the cruise industry & RCL has not changed. In regards to cost-basis, we will continue to monitor where the stock is trading & evaluate any additional buying opportunities.


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