Portfolio manager’s Letter April 2001
The cruise business is in a very competitive business with many big time competitors for the consumer’s vacation dollars, Disney, Las Vegas, resort Hotels, time-shares and other vacation options. But, the Vacation business is a huge industry and cruises are presently a very small portion of the overall market. It is estimated that cruise ships will carry 6.6 million passengers next year.
The business has been growing at about 9% Per year, since 1970 when Carnival Cruise Lines sailed its first ship to the Caribbean and the entire industry boarded a total of 500,000 passengers. Between Them Carnival Cruise Lines and Royal Caribbean Cruise LTD (RCL) have revenues of 6.8 Billion are about 69% of the cruise business.
Warren Buffett likes his purchases to have moats (protective devices to ward off competitors) and he wants those moats well protected with alligators and poisonous snakes. The Cruise industry in general and Carnival Cruise Lines in Particular have some interesting alligators.
Because the cruise companies are foreign corporations, and because most of the business of cruising is done offshore, substantially all of Carnival Cruise Lines income is exempt from US corporate Tax. This means that cruise companies have lower costs and more cash flow to spend on expansion than their competitors in other segments of the vacation business.
Since most of the Companies shipboard employees are foreign nationals and are not US residents they are not subject to US Income tax on wages and the company is not required to contribute Social Security and Medicare taxes on their behalf. These tax advantages are a considerable competitive advantage for the cruise industry because their main competition for the vacation dollar is the theme parks in Orlando and the casinos in Las Vegas. Both of which are very labor intensive and pay lots of taxes.
While most of the recreation industries are intensely seasonal (Las Vegas is hot in the summer and cold in the winter, Orlando has very hot, very long summers). The cruise business can mitigate this seasonality to some extent by moving its best ships to take advantage of seasonal rate premiums. Their ships can sail Alaska in the summer and the Bahia or Caribbean in the winter.
They can sail Scandinavia in the summer and the Mediterranean in the spring and fall. To deal with this alligator the competition would have to put Las Vegas on wheels and to take to Seattle in the summertime, or build a dome over Central Florida and run the air conditioner at 78 degrees for seven months.
For those who have not been on a cruise recently, the prices have been coming down steadily for the last five years. The quality of the food and entertainment has been improving as the industry matures. There are Lots of deals offered and the price of the cruise includes just about everything. In today’s market you can get decent accommodations for somewhere around $100 to $150 per person per night.
This does not include best class cabin on newest ships, but all meals are included, as is pretty much continuous free entertainment. From my point view this a pretty competitive package when compared to a visit to a theme park, unless you prefer standing in line, to eating, drinking, and siting in a hot tub. At my stage of life this is definitely a no brainer.
As far competitive advantages that are unique to Carnival Cruise Lines, it is basically the 800-pound gorilla. Carnival Cruise Lines has 44 ships in operation and 16 more on order for delivery over the next five years. It enjoys a market share of something over 40% of the total North American cruise business. Carnival Cruise Lines was built with acquisitions and includes in addition to the Carnival brand, The Holland America Line, Seabourn Cruise Line, Windstar Cruises, Costa Cruises, and the Cunard Line.
Number two Royal Caribbean Cruises Ltd., which also owns Celebrity Cruises, has 17 ships in operation and 10 more on order. Current market share for RCL is about 29%. Its newest ships are pretty spectacular and include Ice skating rinks and Internet lounges. RCL would appear attractively priced at 10 times earnings compared CCL’s 17, but While Carnival Cruise Lines has been able to build its fleet from cash flow RCL has had to borrow extensively to keep up.
The whole industry is engaged an aggressive ship building campaign and fears that additional capacity will erode profit margins (together with worries about higher fuel costs) has brought the price of both of these stocks well down from their historic highs. I think it quite likely that prices will continue to weaken as this new capacity is brought on line.
But the lower prices will continue to improve the competitive advantage that cruising currently enjoys compared to land based vacation alternatives. It is my feeling that the competition will eventually work to the advantage of the biggest and strongest competitor so I tend to like Carnival Cruise Lines better. But RCL may also be attractive if the current recession does not damage their bottom line severely.
In view of the markets concern about the rate of new shipbuilding I decided to do a spreadsheet on Carnival Cruise Lines ship building program. The following statistics may shed some light on how aggressive it is.
From 1970 to today the North American Passenger traffic has grown at an average annual rate of 9.0%. The CCL annual report gives the following figures for recent history.
Also of interest relative to growth prospects it the recent acquisition of Costa Cruises. In 2000 Carnival Cruise Lines acquired the 50% of Costa that it did not already own, and announced plans for aggressive expansion of Costa’s Fleet. Costa is the large cruise line in Europe. The European Cruise market is much smaller than the North American Market but has been growing at a 15% annual rate in recent years.
Finally there many eventually be a fourth alligator for Carnival Cruise Lines. Since they are a foreign Corp. and operate offshore this may put them beyond the reach of US anti trust law and eventually allow them to build a truly obscene market share.