Cruising to Profits

The more I learn about the global cruise industry, the more fascinated I become. I mean, where else can you find such a winning combination of romance and profits – spectacular ships, exotic destinations, gourmet food and drink, five-star service, and a business model that promises profits for years to come? It’s a far cry from the drudgery of transporting oil or cement, and a lot more rewarding. Transport people instead. And the amazing thing is you really don’t have to take them anywhere. Two miles offshore so they can gamble, “cruises to nowhere” so they can leave the world (and their worries) behind, it doesn’t matter. It’s the journey that counts – sit back and enjoy the ride, and the view. It’s all part of the glamour of cruising and the romance of the sea.

An American Invention
Last year more than 20 million people took a cruise, half of them from the U.S. About one in four U.S. adults has been on a cruise – by far the highest percentage in the world. The U.K. is a distant second at 13 percent. In fact, you could argue that the cruise industry is really an American invention, despite its Norwegian roots. Sixty percent of global embarkations originate in the U.S. with Miami, Port Canaveral and Port Everglades (Fort Lauderdale) being the world’s three largest cruise ports.

The industry is barely 40 years old. It started around 1970 with Norwegian, Carnival and Royal Caribbean in Miami. The whole concept was revolutionary: Up till then no one thought you could just cruise for the sake of cruising. You had to have a destination. Cruising was a form of transportation, a means of getting from Point A to Point B, not an end in itself, and when you got to Point B you got off and stayed. Back then passenger service was largely a matter of transatlantic crossings, and I remember my brother traveling on the S.S. France to his junior year abroad in Europe in 1968. Transatlantic sailings were grand affairs in those days with elaborate send-offs and luxurious accommodations. They were a luxury beyond the means of most people. 

But then came the advent of jet travel, and the great passenger liners suddenly found themselves sitting at the dock. It was cheaper and a lot faster to fly somewhere than to sail. Visionaries like Knut Kloster (Norwegian), Ted Arison (Carnival) and Ed Stephan (Royal Caribbean) saw an opportunity: Take some of the former passenger liners and convert them to cruise ships. The common destination? The Caribbean, where everyone – especially Americans – wanted to go, and could afford to go. There was a precedent for this as in the 1950s and 1960s ships like Cunard Line’s Queen of Bermuda and Queen of Nassau sailed regularly from New York and East Coast ports to the Bahamas. My grandmother would look forward to her cruise every year. The transformation was complete when in 1979 Norwegian bought the S.S. France, at one time the largest and fastest of the transatlantic liners, and renamed it S.S. Norway. After extensive renovations to make her suitable for cruising, she was relocated to Miami and became the grande dame of the Caribbean. 

Facts & Figures
The two major cruise lines – Carnival and Royal Caribbean – control about 75 percent of the market. One of every two global cruise passengers sails on a Carnival ship, one of every four on a Royal Caribbean ship. Throw in the next three largest cruise operators – Norwegian, MSC, and Disney – and you have 95 percent of the market. Carnival’s brands, in addition to its namesake line, include Holland America, Princess, Costa, Cunard, P&O and Seabourn, among others. Royal’s best-known brands are Celebrity and Azamara. 

The Caribbean remains the number one destination, with Europe (including the Mediterranean) second. Nearly 60 percent of all cruise passengers come from North America and 30 percent from Europe. The remainder is divided up among the rest of the world, mainly Australia, New Zealand, Singapore, China and Russia (see Wendy Laursen’s informative “Time to Rethink the Bucket List” article elsewhere in this edition).

Cruise industry executives like to talk about “penetration rates” – the percentage of people that take a cruise each year – and it’s one of the reasons they wax optimistic about the business as a whole. In the two biggest markets, North America and Europe, it’s three percent and two percent, respectively, so there’s lots of room for growth. In Australia, a much smaller market, it’s two percent and growing fast. In the rest of the world – countries like China and Russia and Brazil with huge populations – it’s miniscule, and that’s where the future lies. With a population of over a billion and a growing middle class of approximately 300 million, China offers possibilities that boggle the imagination. A penetration rate of two percent yields six million cruisers, about 30 percent of global cruise passengers in 2012.

More reason for optimism is found in the supply/demand situation. There are about 300 cruise ships in the world and an additional 15 or so scheduled for delivery in the next three years. Meanwhile, passenger growth has averaged eight percent a year recently and should continue at that rate or higher as the global economy continues its slow recovery. So there is no danger of oversupply in this market. On the contrary, it’s a market driven by demand, and while demand has slowed in the more mature markets like North America and Europe, it’s exploding in others.

Another favorite metric is net revenue yield, or how much revenue you take in per passenger, per night, minus travel agent commissions and other costs. Cruisers can easily spend as much on shoreside excursions, drinks, gambling and the like as they paid for the cruise itself, and that increases the yield. Companies are very secretive about the absolute number, but they do talk freely about increases or decreases in net revenue yield in their earnings reports, and it’s a good indication of how well they are performing versus a prior period.

“Floating Hotels”
Cruise lines really have more in common with the hotel industry than with the rest of the shipping business. And that’s why shipping industry analysts don’t follow them. Hospitality analysts do. Cruise lines are really in the vacation business. They are competing with Disney World and Busch Gardens and destinations like Orlando and Las Vegas for the entertainment and tourist dollar. 

What gives them a leg up is their “exceptional value proposition,” which makes them cheaper on average than land-based vacations. For one all-inclusive price you get lodging, food, entertainment, recreation, the opportunity to gamble, and the chance to visit exotic places. And it’s not just any old lodging or food or entertainment. This is world-class quality, and the service to go with it. There are spas and health clubs where you can feel pampered, and pampered you are from beginning to end.
Moreover, there is something for everyone – families, couples, singles, young and old alike. 

It’s no wonder a company like Disney, which had basically invented the theme park concept and was a master at entertainment and hospitality, would decide to cold-start a cruise line in 1994. Four years later the company’s first ship, the Disney Magic, was launched, and there have been three more since. Disney has, by its presence alone, turned Port Canaveral, Florida into the second largest cruise port in the world. Other cruise lines call there, of course, but it was Disney that put it on the map. One of the unique features of the Disney vessels is the lavish use of the company’s lovable theme park and movie characters to entertain guests. Mickey Mouse and Goofy and Donald Duck are ubiquitous and give the ships their family friendly flavor. Taking its cue from Disney, Royal Caribbean has partnered with DreamWorks Animation to bring Shrek, Fiona, Po and other DreamWorks’ characters to life on its ships.

Yet the multi-day cruise industry remains relatively small compared to the global vacation market. The total number of cabins onboard the world’s 300 or so cruise ships is about the same as the number of hotel rooms in just two U.S. destinations – Las Vegas and Orlando.

Cruising to Profits
From an investor’s viewpoint, cruise company stocks look compelling. Despite the Costa Concordia tragedy and the ensuing impact on bookings, Carnival’s stock was up 13 percent on the year and Royal Caribbean 37 percent. Both pay dividends, however modest, and Carnival announced a special year-end dividend of fifty cents per share and pledged to continue its share buyback program.

2013 is expected to show improvement over 2012 as consumer confidence grows and passenger traffic expands in Asia Pacific, South America and, to a lesser extent, North America. Europe is the lone exception to this rosy outlook as the regional economy struggles and the memory of Costa Concordia lingers. Nonetheless, Norwegian Cruise Line in early 2013 announced plans to go public, and it was among the first new offerings of the year. Its owners, Genting Group of Malaysia and the private equity firms Apollo Global Management and TPG, saw reason for optimism and an opportunity to cash in on the global cruising phenomenon.

Compare that to the rest of the maritime business, which remains mired in an oversupply of vessels, stagnant demand and breakeven freight rates. It will be a while before the dry bulk, tanker and container markets get back on their feet. In the meantime, you might want to consider taking a cruise. If you do, tell me about it at Cruise Shipping Miami in March!