While both Kloster Cruise and Royal Caribbean Cruise Line have indicated that they may make go public (initial public offering) in the United States this year, an article in the current issue of Business Week may have put at least a temporary damper on the investment communities' enthusiasm.

In its May 25 issue, Business Week wrote that RCCL's debt load was staggering and that the company's debt will make up 73 percent of total capitalization after the sale of $125 million in bonds. In comparison, Carnival's debt load is 55 percent of capitalization and Kloster's 48 percent.

According to Buisiness Week, the high debt coverage is why RCCL now is mulling a public stock offering this year.

RCCL

While RCCL launched an ambitious newbuilding program, it got "caught" in a market crunch caused by the recession and overcapacity. This in turn has led to discounting which has eroded per diems while costs have gone up.

RCCL has benefitted from economies of scale in the construction of its new megaships, but market conditions have made economies of scale a much more elusive concept in day-to-day operations. Costs of sales, marketing and ship operations have risen in proportion to increases in capacity.

Passenger revenues went up 44 percent in 1988, compared to the previous year, with the introduction of the Sovereign of the Seas, but costs also went up: marketing, sales and administrative costs rose 39 percent and operation costs 36 percent.

In 1989, passenger revenue was up 8.6 percent, operation costs only 1.9 percent, but marketing and sales costs increased another 14 percent.

In 1990, passenger revenue was up 23 percent, operation costs 27 percent and marketing and sales 17 percent. Last year, while passenger revenue rose nine percent, operation costs increased by 19 percent and marketing and sales costs by 15 percent.

Net income has gone from $35 million on operating income of $40.6 million on passenger revenue of $364 million in 1988 to a net of $4 million on operating income of $64 million on passenger revenue of $759 million in 1991. Passenger ticket fares on deposit went from $82 million in 1988 to $108 million in 1991.

Expressed as a percentage of passenger revenues, deposits declined from 19 percent in 1988 to 14 percent in 1991. In comparison, Carnival has maintained its level of deposits representing 12 percent of cruise revenues in 1991 as well as 12 percent in 1988.

Expressed as a percentage of passenger revenue, operation costs were 63.8 percent in 1991 and marketing, sales and administrative costs were 20.2 percent. In comparison, Carnival's operation costs were 58 percent of passenger revenues and sales and marketing costs were 14 percent; Regency Cruises reported operations costs at 51 percent and marketing and administrative costs at 46 percent; and Kloster reported total costs at 91 percent.

The picture shows that RCCL is well­-positioned in the industry. It also shows that Regency Cruises with its smaller and older fleet has lower operating costs than cruise lines with new ships, but spend correspondingly more on marketing and sales.

Despite Business Week's somewhat gloomy report, the outlook for RCCL is excellent, once it can fill its ships with passengers paying higher per diems, and assuming costs are kept under control.

RCCL expects to carry some 700,000 passengers in 1992 each cruising an average of six days for a total of 4.2 million cruise days for the company. Last year, RCCL was only able to report a meagre profit of some $4 million on total passenger revenues of $759.5 million. If RCCL can raise its per diems by $10, it will generate an extra $42 million. In order to bring per diems back where they should be, however, RCCL should be able to raise per diems by $50, which will generate $200 million on an annual basis, adequate to service the company's debt and pay handsome dividends.

The bond sale and the public stock offering will give RCCL some breathing room until the expected market pick-up. RCCL may also be able to negotiate an extended repayment period for its debt payments. It is forecasted that present industry overcapacity will rapidly be absorbed by 1994 as new ship introductions taper off and as the American economy will be back on track. At that time, the cruise lines are also expected to be able to adjust cruise rates upwards.

The combination of reduced debt payments and increased yield would instantly put RCCL on a profitable course.

Fine Line

Cruise ships operate mostly on fixed costs and if they sail with empty cabins that is basically lost money to the company. Once a minimum number of cabins are filled with passengers paying a certain price, costs are covered and any additional passengers become profits.

When the formula does not work is when the market is upset by a recession and/or upset by overcapacity. Then, the prices go down so far that even a ship sailing with a full load of passengers may not generate enough revenue to meet costs.

It is uncertain how the financial markets will react to IPOS from RCCL and Kloster this year. Carnival has demonstrated that cruise lines can be extremely profitable. On the other hand, Carnival's performance can also affect other companies negatively as they may not compare well with Carnival's numbers.

In the past few years, several smaller cruise lines have also gone bankrupt in the market. Regency Cruises has surived for nearly a decade, but can hardly be said to be a good investment potential. Its shares do not move and were trading at $1.41 at press time. Overseas, both Kloster and Costa claim to be undervalued. P&O and Trafalgar House includes their cruise earnings in their shipping divisions, divulging few details, so it becomes difficult to see exactly how well these companies are doing.

Here, however, investment grading firms have given RCCL's bond issue relative low ratings, indicating it is a high risk investment, although they recognize the company's strong competitive position.