On top of all that, this year’s Wave season seemed more like a ripple, leaving the industry to wonder if its traditional annual marketing effort would have to be reinvented to accommodate shifting consumer demand.

Yet, what was sometimes lost in all this bad news was the fact that despite the setbacks, the major cruise lines made a profit and continued to invest in bigger, fancier ships that will guarantee expanded inventory well into the next decade.

Royal Caribbean Cruise Lines’ first-quarter earnings report offered a welcome shot in the arm. Despite a 37% drop in quarterly net earnings, RCCL beat its own and analysts’ expectations in the first quarter.

Overall earnings were down as costs surged, mostly due to fuel prices. As had been expected, the company said the Caribbean was weak while Europe and Alaska were strong. CEO Richard Fain said its premium line, Celebrity Cruises, showed particular strength with its Alaska and Europe summer cruises, while Adam Goldstein, Royal Caribbean’s president, said Caribbean bookings were “not quite at the expectations we had three to six months ago.”

The quarterly report was a change from last year’s first quarter, when both Royal Caribbean and Carnival reported record earnings.

RCCL was the last of the three major players to release its quarterly earnings, and like the reports of its competitors, challenges such as rising fuel prices and weak Caribbean demand pointed to uncertainties in the months ahead.

Carnival Corp. CEO Micky Arison said in March that Carnival experienced a 63% increase in fuel prices in the last year; RCCL predicted its 2006 fuel costs would increase approximately $105 million. The hurricane season is unpredictable, but in a report last month experts at the Tropical Meteorology Project at Colorado State University forecast a “very active” 2006 hurricane season.

At times, the bad news seemed to be coming from all directions at once.

On the same day in March that Carnival reported a 19% drop in net quarterly earnings, a fire broke out on a Princess ship, killing one passenger, injuring several others and causing widespread damage to more than 100 cabins on four decks. Within days, Carnival was advising that it expected the fire to adversely affect full-year earnings by four cents per share.

NCL Corp. CEO Colin Veitch said in February that demand was “short of where we need to be,” attributable in part to the line’s 17% increase in capacity.

Royal Caribbean attributed much of its drop in net earnings to soaring fuel costs and softness in the Caribbean.

These developments point to challenges for an industry beset with questions: Was the weaker Wave season a sign of a slowdown, or is this traditional selling period not the significant measure it once was? Is the relentless negative publicity the industry has endured in recent months taking a toll? And how will cruise lines cope with rising fuel prices and another potentially devastating hurricane season? 

Even as financial analysts scrambled to adjust their Royal Caribbean estimates and reaffirm their faith in the industry, they did so with some caution.

Caribbean concerns

During conference calls with analysts in March and April, executives at RCCL and Carnival were peppered with questions about the clear softening of the Caribbean market.

The concern was not only whether it would continue to slide but whether the slide would spread to other destinations.

“Is the pricing weakness in the Caribbean specific to 2005 residual hurricane fallout,” AG Edwards analyst Tim Conder asked in a recent report, “or a precursor indication of slowing economic and leisure travel?”

Cruise lines have been able to offer no obvious reason for the softening in Caribbean demand this year, though executives at both Carnival and RCCL suggested that last year’s devastating hurricane season was the culprit.

Whatever its impact on demand, the hurricane season clearly took a toll on the industry’s bottom lines -- particularly in Cozumel, Mexico, which prior to Hurricane Wilma was the largest cruise port in the Caribbean, according to the American Association of Port Authorities.

Even the costs of tendering passengers from Royal Caribbean ships into Cozumel “have been disappointingly high, “ said Goldstein, who added that the company has been in talks with the Mexican government to alleviate that.

Wilma destroyed three of Cozumel’s main piers, including one owned and operated by Carnival Corp.

“We had built up Cozumel, as a company and as an industry, as a principal western Caribbean port,” Arison said. “Now we have to regroup.”

Fain said that despite the dip in Caribbean sales, he believes the Freedom of the Seas, which will be the world’s largest ship when it debuts this month, will be a boon to the region by bringing additional attention to the cruise market.

“Freedom of the Seas is helping our company overall by creating a halo over the whole fleet, and I think a little of that is going into the whole industry,” he said.

Fain added that the ship is selling “gangbusters” in the western Caribbean, the weakest area of the Caribbean.

“I wish we could say there won’t be many hurricanes,” Fain said. “The beauty of cruise ships is that we can mostly avoid them.”

It’s the economy, stupid

Several analysts and agents offered explanations other than weather.

“Some customers say they do not want to travel this hurricane season, but I don’t feel it is any more than normal from past hurricane seasons,” said Todd Szopinksi, president of Buycruises.com in Margate, Fla.

High gas and oil prices, he said, are “robbing our customers of their hard-earned vacation savings.”

And with airline tickets doubling in price, he added, passengers are having difficulty getting affordable air to Caribbean departure ports. Szopinksi also blamed cruise lines for offering lower prices closer to sailings, when most customers have already made other plans. 

Conder of A.G. Edwards asked if the Caribbean weakness might mean that the region is falling out of favor. “Is there a ‘been there, done that’ attitude developing among the growing pool of experienced cruisers related to the Caribbean?” he wrote.

Conder also wondered if Alaska and Europe itineraries were doing well because they appeal to a market that is less sensitive to “a slowing in economic activity”.

He was among analysts who theorized that because the Caribbean, on average, is a less expensive cruise option than Alaska, Europe and other distant locations, it attracts clients who are more susceptible to an economic downturn and thus won’t cruise at all when belts tighten.

Yet the lines themselves tended to downplay economic factors. Carnival COO Howard Frank accepted the possibility that, in addition to hurricanes, consumer confidence and other economy-related issues might be culprits in the Caribbean. But he wondered if that logic made sense, given that the other cruise regions were strong.

“Why the economic issue wouldn’t affect all destinations, I’m not sure,” Frank said.

The Conference Board, a private research group, reports that its monthly measure of consumer confidence has been on the rise every month since November, except for a downturn in February, the heart of Wave season.

“Consumers are growing increasingly concerned about the short-term health of the economy and, in turn, about job prospects,” the February report noted. “The expectations index [consumers’ six-month outlook] is now at its lowest level in three years.”

Yet, the consumer confidence index rose in April to its highest point since May 2002. The Conference Board said that labor trends were driving the increase but cautioned that rising gas prices “could dampen consumers’ mood.”

Robert Kwortnik, an assistant professor of marketing at Cornell University’s School of Hotel Administration and a cruise industry expert, said he still believed the cruise industry was healthy in the long term but that the economy posed the biggest threat to demand.

“As a consumer, this is just a tough time to be thinking about spending money on leisure,” he said. “When you see how expensive all the forecasts are for air travel over the summer, it starts to hit people in the pocketbook psychologically. If there’s any weakness in demand it’s due to the economy, not the industry.”

Wave season disappoints

The 2006 Wave season, the industry’s high period of cruise bookings, has been described as weaker than in years past. Jack Mannix, President and CEO of Ensemble, said that this is true even though some consortia, like his, will enjoy record sales years.

“We will have a record year, but we will only be up a modest amount in growth” compared with 2005, Mannix said. “Wave has been not quite as strong as a lot of us had hoped.”

In late February, NCL’s Veitch was the first of the top cruise executives to say his company was not seeing the kind of “robust” Wave season it had experienced the previous year. Rick Sasso, U.S. CEO of privately owned MSC Cruises, said in March that it had been “a good Wave, but not a tremendous Wave.” Sasso suggested that marketing and advertising in late 2005 might have created demand early, thus sapping the strength of bookings during Wave season, which typically runs through January, February and March.

“Wave has definitely become less and less important to the cruise business,” said Greg Johnson, RCCL’s associate vice president of investor relations. “There is still somewhat of a wave or bubble for bookings, but it’s not as dramatic as it used to be.”

Johnson explained that Wave season became huge when demand far outstripped supply. Bookings needed to be made in advance or inventory would be gone.

“Because the industry has grown so much, our demand is more balanced with supply,” he said. “Even though there is more demand, the options are much broader, so there will still be inventory left.”

Mannix also noted that the Wave concept was being tested by the extension of the average booking time; he said bookings were being made much further out than they used to be.

“When the Wave concept started, it was because there was a pop [early in the season] and we would say, ‘It’s Wave week,’ “ Mannix said. “Then there was Wave month, then it become Wave season. Maybe there’s an expansion of that, and it’s no longer compressed in a short-term booking season.”

In late March, Arison suggested that the successful 10-week Wave seasons of the last couple years had been an aberration.

“Historically, Wave season was a six- to eight-week phenomenon,” he said. “I think what has happened is the booking patterns moved back to a more traditional booking pattern and more similar to what we saw prior to the last two years.”

Glen Reid, an analyst with Bear Stearns, said that cruise patterns might simply be “normalizing.”

“While the cruise business remains relatively healthy, our thesis has been and continues to be that the fantastic snap-back in demand following 9/11 and the Iraq War would moderate this year,” he said in a report.

The biggest risk of further softening in the market, he added, “is a weakening consumer.”

Sticker shock at the pump

Perhaps the biggest overall threat is the cost of fuel, a theme analysts have focused on in their recent estimates. 

The average cost of unleaded gas edged over $3 per gallon in the U.S. the same week that Royal Caribbean held its conference call. Crude oil traded above $73 a barrel last week, 45% higher than a year earlier.

The line’s earnings report said fuel had accounted for 7.6% of its increase in net cruise costs, jumping to an average of $418 per metric ton, compared with $284 in the first quarter of 2005.

Though the company hedged 46% of its fuel, A.G. Edwards’ Conder observed that since most of 2006 was already booked, there was “limited upside opportunity in revenue to offset any further potential spikes in fuel prices.”

Goldman Sachs analyst Steven Kent praised Royal Caribbean for hedging so much fuel, saying the increase from 16% to 46% “should reduce volatility.”

The report also noted that, as of late March, Carnival was “0% hedged.” Goldman subsequently issued an “outperform” rating for Royal Caribbean and downgraded Carnival to an “in line” rating.

But in both cases -- and despite the speed bumps and bad publicity -- analysts recommend that investors hang on.

“Despite rough waters near-term, we continue to view the cruise industry as having attractive long-term fundamentals,” said Jake Balzer, a leisure analyst at Guzman & Co.

He cited positive demographics and cruising’s “value proposition relative to land-based vacations.”

Matching supply to demand

Analysts also expressed relief that ship orders seem to have slowed, mostly because, as Arison noted at the Cruise Lines International Association’s industry conference in Fort Lauderdale last month, there are currently so many ships on order that there is simply no shipyard availability to build more.

“What you see is what you get through 2009,” he said. “It just can’t be ramped up, because of yard capacity.”

If the consumer attitudes can be considered reliable predictors,  the cruise lines should be happy to see that despite fuel costs and interest rate spikes, April recorded the highest consumer confidence rating in four years.

As for weakness in the Caribbean, cruise lines have been looking beyond their bread-and-butter region for a while.

Europe has never seen so much deployment -- Princess, Celebrity, Disney, Carnival and Royal Caribbean are all increasing their presence on the Continent this summer and next. Alaska is filled with ships. Places like Dubai now have the infrastructure to be homeports. And Carnival Corp. is venturing into the Asia market in July via its Costa brand.