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Stock Strategist Industry Reports

Cruise Operators Sailing Into Calmer Waters

As headline risk subsides and demand normalizes, improving operating and cash flow metrics could support substantial upside for cruise line stocks.

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 Carnival (CCL) and  Royal Caribbean (RCL) have weathered one of the cruise industry's most difficult periods in recent memory. After scrambling to redeploy Southern Mediterranean capacity in 2010 because of political instability in countries like Libya and Egypt, the companies sailed into a year that saw more turmoil in its promising European base, with key sourcing countries (Spain, Italy, Greece) facing austerity measures, high unemployment, and overall economic duress. In addition, the Costa Concordia disaster off the coast of Italy, which portrayed the safety protocols of cruise ships in a less than favorable light, plagued the lines.

We believe that the external noise that has limited Carnival's and Royal Caribbean's stock price growth over the last eight months is largely in the past, and that more normalized patterns of demand and pricing will resume over the next few quarters and, more important, into 2013's wave season. While Europe could continue to drag on overall profitability in the near term, stabilization in the U.S. market with forays and expansions in newer geographic markets could provide longer-term opportunities for expansion. We don't see a change to our narrow economic moat rating for either company over the foreseeable future thanks, to their scale and barriers to entry.

Jaime M. Katz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.