Book These 5 Bargains in Leisure

Today's stock market isn't cheap. According to Morningstar's Market Fair Value graph, the average stock in Morningstar's coverage universe is slightly overvalued.

Yet, there are still pockets of opportunity--one pocket being leisure stocks, which includes a hodge-podge of travel, lodging, and recreation names. As a group, these companies are trading about 15% below fair value as of this writing.

To some extent, the market's general lack of interest is understandable. Ongoing competitive threats--including direct bookings with hotel chains--have cast a cloud over some online travel stocks, says Morningstar senior equity analyst Dan Wasiolek. Further, we're now in the later innings of the current hotel cycle: 2016 is year seven of positive RevPAR (a measure of hotel-industry strength that looks at both occupancy and average nightly rates) growth, he says. The average historical cycle lasts seven to nine years, which suggests that the best revenue growth for lodging stocks may be behind us. And cruise lines have generated inconsistent revenue growth during the past few years, notes Morningstar equity analyst Jaime Katz.

Yet there's much to like about some of these stocks at these prices. Here's what leisure stocks have going for them long-term, their risks, and some of Morningstar analysts' picks today.

Long-Term Prospects vs. Risks
Two demographic groups may help push selected leisure stocks upwards: baby boomers and millennials.

With most baby boomers entering or enjoying retirement, they finally have the time and money to spend on leisure activities. Cruise lines stand to benefit, says Katz. She expects demand from baby boomers to overwhelm the supply of berths over the next five years.

Millennials, meanwhile, are poised to spend on leisure and travel in general. According to a survey by market-research firm Harris Poll and Eventbrite Inc., more than 75% of millennials would rather pay for an experience or event over buying material goods, which could be good news for this market.

Of course, short-term economic developments could dim the prospects for leisure stocks. The travel industry is cyclical and affected by changes in economic growth. For example, in 2009 following the financial crisis, Priceline's booking growth slowed to 26% from the 53% reported in 2008. Hotel industry RevPAR was down 17.1% in 2009, while U.S. GDP growth was down 2.8% that year.

Competition also poses a threat. Focused entry from  Google (GOOG),  Facebook (FB),  Amazon (AMZN), and others into online travel could lead to commodization of the industry and threaten the profitability of existing players, says Wasiolek. Alternative lodging solutions, such as home and apartment rentals and the shared economy, threaten traditional lodging revenues. And volatile energy prices, rising geopolitical uncertainty, and fluctuating foreign exchange rates can take a short-term toll on cruise companies.

Morningstar Analysts' Picks
Those interested in leisure stocks have a handful of quality, well-priced names to choose from. All of the stocks listed below earn economic moat ratings of at least narrow, which means that our analysts think that these firms can fend off competition and earn high returns on capital for many years to come. In addition, these companies all have stable or positive moat trends, suggesting that their competitive advantages are steady or growing, not declining. Lastly, these stocks are all trading in 4-star range as of this writing, meaning that they're underpriced relative to our estimate of their fair values.

 Priceline (PCLN)
Rating: 4 stars
Economic Moat: Narrow
Moat Trend: Positive
When it comes to online travel stocks, the market is not factoring in strong cash flows that the industry produces, says Wasiolek. He sees the online travel companies as large, growing, and generating strong returns on invested capital and cash flows in what is a low-capital-intensive industry.

Four-star Priceline is the world's largest online travel agency by revenue. The company operates Booking.com, Agoda, and OpenTable, among others. Priceline earns a narrow moat rating thanks to its expanding global network of hotel properties and other services, which is becoming more and more difficult for a challenger to replicate. This network also positions Priceline well for the increasing global shift to booking via mobile applications.

"We expect Priceline's global online travel agency leadership position to expand over the next decade, driven by a superior position in China, continued leadership in Europe, and expanding presence in vacation rentals and restaurant bookings," he says. "We see the firm's global share of total travel bookings reaching high single digits in 2020 from 4.7% in 2015."

 Carnival (CCL)
Rating: 4 stars
Economic Moat: Narrow
Moat Trend: Stable
"We believe share prices [of cruise operators] have fallen significantly enough due to near-term risks to provide a wide margin of safety for investors," says Katz.

Four-star Carnival is the largest company in the cruise industry, operating 10 global brands with more than 100 ships in service and passenger capacity of more than 215,000.

"Carnival's position as the largest cruise operator also allows it to leverage items like port commissions, marketing, general overhead costs, and maintenance efficiencies across the industry's largest fleet of ships," she says. "This allows Carnival to generate best-in-class returns without gouging its customer base with high prices."

 Royal Caribbean Cruises (RCL)
Rating: 4 stars
Economic Moat: Narrow
Moat Trend: Stable
The three biggies in the cruise market--Royal Caribbean, Carnival, and Norwegian--control nearly 90% of the North American market, according to Katz. "The significant share of capacity that is represented by these three companies is enough to prevent most would-be rivals from entering the marketplace and directly competing with the incumbents," she says. In other words, it's nearly impossible for a new competitor to enter this market and scale up quickly enough to pose a threat to this oligopoly.

The world's second-largest cruise company, 4-star Royal Caribbean, operates more than 40 ships across six brands in the cruise vacation industry.

"Royal Caribbean's brands continue to drive repeat business, as the innovation and quality of its vacation products remain topnotch while offering a compelling value proposition to travelers," says Katz in her latest Analyst Report on the stock. "The company's focus on pricing integrity, which avoids close-in discounting, could ensure the brand remains strong and yields can rise in the longer term."

 Norwegian Cruise Lines (NCLH)
Rating: 4 stars
Economic Moat: Narrow
Moat Trend: Stable
The third-largest cruise company, 4-star Norwegian Cruise Lines, operates 24 ships across three brands (Norwegian, Oceania, and Regent Seven Seas).

"Of the three, we see Norwegian as the most undervalued at this time," says Katz in her new report on the cruise industry. "Although it remains the most leveraged of the publicly traded cruise companies, raising its risk profile, Norwegian currently has the most potential to grow capacity from its current levels, while benefiting from its primary focus on healthy U.S. consumers (the company still sources more than 70% of its cruisers from North America)."

 Wynn Resorts (WYNN)
Rating: 4 stars
Economic Moat: Narrow
Moat Trend: Stable
This 4-star casino and resort operator has a narrow economic moat, thanks to one of only six licenses awarded to operate casinos in China. Its focus on the high-end luxury segment of the casino industry allows it to generate high levels of revenue and EBITDA per gaming position in the industry.

"We view Wynn Resorts as a high-end iconic brand that is well positioned to participate in the attractive long-term growth opportunity of Macau," writes Wasiolek in his latest Analyst Report. He expects growth to accelerate after 2018 as key infrastructure projects that alleviate Macau's congested traffic come on line, which will expand the region's constrained carrying capacity, thereby driving higher visitation levels.

Ashley Redmond is a freelance columnist for Morningstar.com. The views expressed in this article do not necessarily reflect the views of Morningstar.com.