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Royal Caribbean continues to battle China skeptics

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Ovation of the Seas in Tianjin - generating superior yields, even by China standards (Photo: Royal Caribbean)
Investor concerns about the cruise industry growing too fast in China sank Royal Caribbean shares Tuesday. So Richard Fain told CNBC shortly after he'd devoted a good chunk of the company's earnings call to chipping away at such concerns.

RCL closed at $67.35, down $4.51 or nearly 6.3%.

Royal Caribbean turned in a stronger than expected second quarter profit but trimmed its full-year outlook 20 cents per share at the midpoint on foreign currency and fuel cost. Management described the company's overall booked position as strong in volume and rate, while mentioning some weakness in the Eastern Mediterranean and in Shanghai.

Anticipating concerns about mentioning weakness and China in the same breath, Fain had opened the earnings call by framing the market in a historical context. Similar to North Americans several decades ago, most Chinese don't know what cruising is, only a small number of travel agencies sell cruises, itineraries are limited and growth is episodic, driven by new ships.

The North American market didn't grow in a linear way, and neither will China, Fain said. Where China differs, though, is pace of growth and scale.

Its cruise distribution network is ramping up fast, and capacity growth has been bounding ahead at rates of 40% or 50% resulting in only modest pricing softness. Fain called that 'extraordinary.' In the West, the market had trouble keeping up when capacity grew in the double-digits.

So now industry capacity has been rising in the triple-digits in China, and that's a challenge. However, Fain told analysts China's ability to fill twice as many berths this year as last with only modest softness is a sign of great strength.

'It's hard for me to imagine an industry where you suddenly double capacity in a year and have to make only a relatively small reduction in your pricing,' the Royal Caribbean chairman said.

Capacity in Shanghai has increased about 100% in 2016, and cruises from there comprise approximately 65% of China's business, according to Michael Bayley, president and ceo, Royal Caribbean International. He said capacity growth in Shanghai will be much lower in 2017, about 15% or 20%.

China represents 9% of Royal Caribbean's overall capacity, and the market continues to generate above-average yields, with load factors in line with the fleet average, cfo Jason Liberty said, adding that the market is accretive to yields and return on invested capital.

It's been just over a month since the company introduced Ovation of the Seas in Tianjin, and Liberty said the ship is generating superior yields, even by China standards. Overall, the pace of China bookings has been mostly within the expected range and above last year. But in recent weeks there's been some softness of demand for close-in Shanghai sailings.

All in all, Royal Caribbean is very pleased with how its cruises are being received by Chinese customers, the acceptance of the brand and how the government values the business as part of its overall economic expansion.

During the earnings call analyst Harry Curtis of Nomura Securities expressed one of investors' fears as that if China doesn't live up to expectations, operators will pull back capacity into traditional markets, potentially hurting pricing there.

Fain stressed that would not happen. Deployment is set for 2017 and this is a long-term business, he said.

China is a 'very powerful market,' Fain stated, adding he doesn't see any change in that due to a bit of pricing weakness now.