Some Resilience Can Be Found in Travel & Leisure

While American households prepare for their summer vacations, we wanted to find out how well the domestic travel & leisure industry was holding up amid a sluggish U.S. economy. Zacks senior travel & leisure analyst Sean P. Smith was on hand to give us his outlook.

Carnival Corp. posted a positive surprise in its latest quarterly report, but is there some negative sentiment in the cruise line industry overall, presently?

Carnival (CCL) did exceed the consensus earnings estimate in the most recent quarter, but the company also lowered its full-year outlook. Top-line revenue and booking trends have remained resilient, although the cruise companies are experiencing lower on-board spending in light of the current economic downturn.

The high cost of fuel, however, is having a significant negative impact on the bottom lines of the cruise companies. Carnival expects that fuel expenses in 2008 will be $752 million greater than in 2007, reducing 2008 earnings by $0.92 per share. With the stock currently trading at a multiple of roughly 13x expected 2008 EPS, the negative impact exerted on the share price by the higher fuel expenses is substantial.

What about the hotel industry? What trends do you see here?

The hotel industry is feeling the impact of the weak U.S. economy. For example, Marriott (MAR) recently lowered its outlook for second-quarter revenue per available room (RevPAR) growth in North America to approximately 2%, down from the company’s previous expectation of 3% to 5%. The company also stated that it would be surprised if the current RevPAR environment in North America improved in the second half of the year.

With individual consumers feeling pressures from the declining housing market, high gas prices and an increasing rate of inflation, hotel companies are limited in their ability to push room rates higher. The increasing focus on cost-cutting by U.S. corporations extends this pressure to business travel, which is the most profitable segment for lodging companies.

Are their any travel and leisure segments that look particularly strong these days?

In the lodging sector, the international segments of hotel companies are in general expected to generate better operating results than domestic properties. As such, companies with geographically diversified portfolios are likely better positioned to withstand the current economic environment. Additionally, higher-end properties are continuing to outperform brands with more modest room rates, as the current economic downturn has generally had a less significant impact on the affluent.

In the cruise industry, the demand picture remains relatively strong. Many consumers would prefer to cut back on other day-to-day expenditures as opposed to forgoing an annual vacation. Additionally, the perceived value offered by the cruise lines remains high, relative to other potential vacation trips. So, while the impact of higher fuel prices remains a significant drag on the bottom line, the demand picture in the industry remains encouraging.

Where should investors be wary of investing their money within this general space?

From a macro perspective, we would avoid lodging companies without a geographically diverse portfolio, and companies without sufficient balance sheet flexibility to opportunistically execute their business plans. In the cruise industry, we would be wary of companies that do not utilize a fuel hedging program, due to the low level of operating expense visibility.

From a stock-specific perspective, we would avoid shares that continue to be priced at a premium, or that trade a multiple that does not fully account for the realities of the present economic environment.

Do you have any top Buys for us at this time?

On the lodging side of the industry, we have a Buy rating on Starwood Hotels & Resorts (HOT). We believe that the company’s geographically diverse, high-end portfolio is well positioned for the long-term.

In the cruise industry, we prefer Royal Caribbean (RCL), based primarily on valuation. The company trades at a significant discount to its largest peer. The company also hedges a significant portion of its fuel expenses, enabling investors to focus primarily on the company’s operating business, as opposed to speculating on the future price of fuel.

Sean P. Smith is a senior analyst covering the travel and leisure sector for Zacks Equity Research.