The following is a reprint of my January 29, 2008 RealMoney column.

Last week’s wild ride for consumer-sensitive stocks made the seas a little rough for cruise ship operators Carnival Corp. & plc (CCL, CUK) and Royal Caribbean International (RCL). The general feeling, apparently, was that a consumer slowdown would keep people from taking cruises, while a tax rebate might be spent on one.

Hogwash, I say. In each of the last 12 years, the combined revenues of Carnival and Royal Caribbean increased. The worst year for either company was the 4% revenue decline Carnival suffered in 2002. While it is true that the last recession was not consumer driven, the companies also held up well in the early 1990’s recession.

There have been lots of theories as to why cruises haven’t lost their luster during times of economic hardship. Some say it is because the cost per day of cruising compares favorably to other vacation alternatives, making a cruise even more attractive during hard times. Others attribute it to the relative immaturity of the industry during the last consumer recession.

I say the answer is in plain sight, right on the companies’ balance sheets as a line item called “Customer deposits.” Cruises are often booked 6-18 months in advance, and a non-refundable deposit (typically several hundred dollars per person) is required upon reservation.

At the time the customer books the cruise, the economy looks fine. By the time the customer realizes times are tough, a significant portion of the cost is already sunk and the customer figures, “I might as well go.” Only if the recession is prolonged enough for customers to stop making advance bookings would the lines be likely to see a falloff in business.

So far, that doesn’t seem to be much of a concern. Carnival’s advanced deposits ended the year (their fiscal year-end is November) at $2.8 billion, up 20% from the prior year-end. Sales, meanwhile, grew just 10%. When earnings were released on December 20 the company said, “Advance bookings for the first half of 2008 are well ahead of last year in terms of both occupancy and pricing, on a cumulative basis. Advance bookings for the second half of 2008 are also shaping up in a similar fashion to the first half of the year, although it is still early in the booking process.”

Those tax refund checks may come at an opportune time after all.

Valuations for the stocks look reasonable. Both companies are trading at a P/E of about 14x trailing earnings and a price-to-book ratio of about 1.2x. The consensus long-term growth estimate is 14% for Carnival and 12% for Royal Caribbean. Even with further compression of price multiples (I actually think the opposite is more likely) the stocks could offer double-digit returns from here.

Based on the current valuation and outlook, I think the choice between the two is a no-brainer in favor of Carnival. It has slightly higher growth expectations, a significantly higher ROE, and similar valuation multiples.

What’s more, Carnival is the industry leader with 85 ships offering 158,000 lower berths and 22 new ships scheduled to enter service between April 2008 and May 2012. Royal Caribbean has “just” 35 ships and less than half the passenger capacity.

What’s more, Carnival has cornered nearly every part of the cruise market. Its lines include the low-cost “fun ships” of Carnival, the mid-range “Love Boats” of Princess, the upscale, older-skewing Holland America and Cunard to the ultra-luxury Yachts of Seabourn.

Finally, Carnival’s greater size means it can continue to invest in new ships (which cost hundreds of millions of dollars each) without requiring substantial outside financing. Its cash from operations have exceeded capital expenditures in three of the last four years. Meanwhile, Royal Caribbean has spent more than it generated from operations in each of the last two.

Analysts expect the company to earn $3.47 in the fiscal year ending in November 2009, and Carnival’s average P/E over the last five years has been 19x. If Carnival gets that multiple again, the shares could rise 58% to $66 over the next two years.

Even a more modest scenario offers attractive upside. A P/E expansion to just 15x (which I think could happen come consumer slowdown or high water) would still allow for a $52 price and double-digit annual returns over the next two years.

Royal Caribbean Cruises Ltd. (RCL) announced net income for the second quarter 2007 of $128.7 million, or $0.60 per share, compared to net income of $122.4 million, or $0.57 per share in 2006. The results were consistent with previous guidance of $0.58 to $0.63 per share and the $0.59 consensus. Revenues for the second quarter 2007 increased to $1.5 billion from revenues of $1.3 billion in the second quarter 2006 and well ahead of the $1.42 billion consensus. The company also announced that the full year earnings guidance is substantially unchanged except for the impact of higher fuel prices. The company does not forecast fuel prices, and, adjusting for current spot pricing, full year 2007 earnings are expected to be $2.75 to $2.85 per share, compared with a consensus estimate of $2.95.

So we see revenue ahead of estimates but earnings at the low end of guidance, and this is supposed to be fuel costs? Seems a little excessive. The significantly lower earnings for the next couple of quarters also is supposed to be on fuel, but could it be lower load factors affecting the fixed cost structure?

RCL was a long-term holding of mine, but I sold it nearly a year ago due to premature consumer slowdown fears.  The stock is up modestly from where I sold it, though it has been essentially flat for much of that time. Cruise companies tend to trade poorly during consumer recessions even though their fundamentals generally hold up well. If the current market jitters continue I might be tempted to get back in.

Our earnings preview for Garmin (GRMN - Annual Report) said it “shouldn’t need a big surprise to move the stock from this level.” Today the company reported earnings:

First Quarter 2007 Financial highlights:

– Total revenue of $492 million, up 53% from $322 million in first quarter 2006

– Earnings per share increased 60% to $0.64 from $0.40 in first quarter 2006; excluding foreign exchange, EPS increased 37% to $0.59 from $0.43 in the same quarter in 2006.

These results compared to consensus expectations of $0.59 on $499 million in sales. So the stock did indeed move on a not-big surprise, albeit one in the opposite direction from which we implied. The company did not change its prior guidance, saying:

We remain optimistic about the future success of our business and our ability to serve customers and distributors around the world. We anticipate overall revenue to exceed $2.5 billion in 2007, and earnings per share to exceed $2.70 assuming an effective tax rate of approximately 13 percent. We anticipate automotive/mobile revenues to grow faster in 2007 than we earlier anticipated, and continue to expect declining operating margins due to product mix and a continued transition toward mass market levels. We intend to provide a formal update to our fiscal 2007 financial expectations during the Q2 2007 earnings conference call.

Unfortunately, analysts were already ahead of those expectations, calling for $2.81 in EPS on $2.54 billion in sales. Without a significant surprise in Q1 or a significant surprise forecast for Q2, the estimates are starting to look a bit out on a limb.

Add this data point to the ones provided by Royal Caribbean (RCL), Plantronics (PLT), Radio Shack (RSH) and Circuit City (CC) that consumer spending may be slowing.

Royal Caribbean Cruises (RCL) reported earnings:

Royal Caribbean Cruises Ltd. (NYSE: RCL; Oslo) today announced net income for the first quarter 2007 of $8.8 million, or $0.04 per share compared to earlier guidance of $0.03 to $0.08 per share. The company also reaffirmed its full year 2007 earnings per share guidance of $3.05 to $3.20.

Analysts were expecting the company to earn $0.06 on $1.18 billion in revenue. However, the company attributes the shortfall to the volatile sales pattern at a recently acquired subsidiary:

As the company had anticipated, the acquisition of Pullmantur and other timing changes caused significant changes in the seasonality of company earnings. These changes make comparisons between individual quarters less meaningful (especially for the first year of the acquisition) but have little impact on the profitability of the year as a whole. In particular, Pullmantur’s business is highly seasonal with very strong summer months but very weak winter months. In addition, the company is including Pullmantur results on a two month lag. Together, these changes significantly diminished the company’s reported earnings in the first quarter, and are expected to do so again in the second quarter, but are expected to commensurately improve earnings in the third and fourth quarters.

In other words: we promise we’ll make it up to you. Normally skeptical investors appear to be taking the promise in stride, as the stock is little changed on the day. This is somewhat surprising, as the company disclosed weakness going beyond the acquired company and straight to its core:

The demand environment, especially in the Caribbean, has been weaker than expected. At the same time, cost control has been good, offsetting the revenue decline.

First quarter 2007 Net Yields on a comparable basis (i.e. excluding Pullmantur) decreased 4.2%, which was below guidance of down 2% to 3%. Commenting on the revenue environment, Richard D. Fain, chairman and chief executive officer said, “After a strong Fall performance, close-in bookings in the first quarter required more aggressive price promotions than we experienced throughout the last year.”

We owned shares of RCL for several years but sold them back in August when we got especially worried about consumer spending.  So far that trade has been making us look silly, but comments like those above make us feel less embarrassed by it. To be sure, indicators such as customer deposits (which are typically nonrefundable) are strong. But the consumer spending outlook remains questionable, and even if customers don’t walk away from existing deposits there is still the potential for further slowdown.