In this episode of Industry Focus: Consumer Goods, hosts Emily Flippen and Asit Sharma dive into the cruise industry, breaking down the trends, metrics, and numbers that investors should study to make sense of the space. Then, they look at the three biggest cruise line operators and how they compare to each other. Learn what makes cruise lines so similar to airlines, and what makes them critically different; how the three big cruise stocks compare to each other; how cruise lines are attracting younger travelers; how cyclicality affects the industry, and where in the cycle we are today; and much more.
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This video was recorded on Jan. 21, 2020.
Emily Flippen: It's Tuesday, Jan. 21, and I'm your host, Emily Flippen. Today, we're taking a deep dive into what is one of the underrated consumer goods services, in my opinion, that's cruises. Joining me today is Asit Sharma. Asit, thank you so much for coming!
Asit Sharma: Thanks for inviting me, Emily! I am eager to cruise on into this topic.
Flippen: So, when I was doing my initial research, I was so intrigued. I'm 25 years old, I've never been on a cruise, and honestly, the cruise industry is not something that I, in my experience, had spent a lot of time thinking about, either as an investor as a consumer. But I noticed some research said at the end of 2018, there were over 50 cruise lines across the world, and nearly 30 million passengers took at least one cruise last year. It just struck me as a huge number for an industry that I had essentially no exposure to.
Sharma: Yeah. In fact, it flies under the radar, I think, of most of the consumer goods screens that you might take if you're into screening for stocks. You see a cruise line -- we're going to talk about this, there are not very many of them that you can buy -- and it's just sort of this peripheral thought. However, it's a big industry. There are huge numbers of ships carrying huge numbers of passengers with billions of dollars that are being spent every year. It's one that I think is really interesting to explore, great for long-term investing, and it's sort of cyclical, so maybe there are opportunities when times aren't so good to buy into the stocks. And we can talk about as we go along why this is a cyclical industry. I'm sure most investors can sort of guess in advance of that part of our conversation.
Flippen: Yeah. So, when you think about the cruise industry, I mean, we talk about it being cyclical. Of course, people, whenever they have discretionary income, are more likely to spend money on vacations in general. But do you think there's anything compelling about the cruise experience that could make someone say, "Hey, I want to go on a cruise," versus just buy a flight? Because flights are increasingly cheap, aren't they?
Sharma: They certainly are, getting cheaper by the year. Myself, I've been one cruise in my life, and that was when I was in my early 20s. So, like you, I look at it more from an investment angle than one of extreme interest. But I think that the cruise industry has some really compelling reasons for people to take a look, whether you're an investor or just someone who wants a break from your typical vacation. I mean, it's an opportunity to travel with minimal effort on your part. Just reach your port, get on your ship, and life is taken care of for you. That appeals to our sense of luxury and indulgence, and also the idea of personal restoration. I should also say, it also taps into our ongoing fascination with the sea that many of us have when we're small. It's something that has this aura of romance about it, but also that satisfies a wanderlust that I think we all keep buried somewhere inside of us, even with a nine to five that we have to sort of slog through. And also, there's this new generation of ships which have innumerable recreation, dining, shopping, entertainment, gambling, personal care options. And they're also enabled with a bunch of tech, which wasn't the case in the past. So, if you haven't taken a cruise in a long time, it's probably a different experience than you remember, and one that holds immense fascination, whether you're slightly middle-aged person like myself -- I'll try to put the best sheen on it that I can [laughs] -- looking to capture some of that romance of the sea, or you're a younger person who may be looking for a supremely Instagrammable experience, they have something for everyone now.
Flippen: I love the fact that you touch on the fascination with the sea. I can't speak for anybody else, but my life has been about avoiding the sea. I think I watched "Titanic" at way too young of an age, and was scarred about drifting off into the cold ocean. But, to your point about having it be a luxury experience, I think a lot of conceptions that people have historically about cruises is that they are luxury, that they're something that's kind of expensive, you're paying up, it's almost like going to an all-inclusive resort. But, as with all of those things, there's a big down-market shift for these cruises as well now, right? My impression of the industry is that, instead of paying a high upfront fee to get in, like you would do historically, now, it's a much lower fee, but they upcharge you, right? It's that discount airline experience, where they're making a majority of their money by getting you to buy drinks on board, or buy experiences on board.
Sharma: Yeah, I think that the cruise industry has done a really good job of replicating some of the strategy of the airline industry. The big legacy characters like Delta and American now offer this entry-level seat to compete with the scrappy carriers like Spirit Airlines. They have something for every budget. And in the cruise industry, we see especially in the U.S., there's an itinerary that basically goes from the port cities -- Fort Lauderdale, or Miami -- back and forth to the Caribbean. And the cruise companies can offer three- to four-day cruises at an extremely affordable rate. So you can have your total cost average about $70 to $100 per day for a three- or four-day cruise. That's accessible to a wide number of travelers. Now, they also go very, very upmarket. So, you can take a seven-day itinerary on a luxury cruise line -- say, Silversea, Cunard, or Viking. Those will start anywhere from $3,500 to $5,000, and they'll go on up. And, of course, in between those two extremes, there are a lot of great cruises on the newest and biggest ships in the business. One that I have been following this year is the Norwegian (NYSE:NCLH) Bliss. That ship, for under $1,000, you can get a seven-day cruise, and then partake in some really cool activities. But as, Emily, you point out, once you get on board, those really awesome activities like the [go-kart] racetrack that's on the Norwegian Bliss, you have to pony up some more dollars for that. So, the whole thrust is actually, as you say, to get you on board and have you spend on board.
Just one stat I'll throw at listeners. I was looking at Norwegian Cruise Lines. Their year-to-date performance for the three quarters from last year that we already have booked, their revenue, about 30% of it came from onboard spending last year.
Flippen: That's amazing. And in the process of doing research for this, I personally went out, and I was looking on these websites, and I feel so compelled to take a cruise now after digging around a little bit on Norwegian, some on Carnival (NYSE:CCL). But, yeah, I noticed that as well. You pay a base amount per day, and you end up paying a little bit more on board. And, one of the things that you mentioned to me when we talked previously was that, I was seeing a lot of low prices because of what you called a "wave season?"
Sharma: Right. So, wave season, it sounds like a season you should avoid, because there are big waves on the ocean. It actually means something quite different. It's a really important season for both investors and travelers. When we were chatting yesterday, I was telling you, we're in the middle of it. Actually, we're more in the beginning of it. It runs every year from Jan. 1 to roughly the end of March. This is the time of the year when the big cruise companies are filling up the last, say, 40% to 50% of their capacity. They sell a lot of next year's bookings before the end of December. And then, they want to incentivize us to travel. And, at the same time, travelers are looking for a bargain. So, it's sort of a dance that's now set in stone. So, if you're listening today, and you're persuaded by Emily's enthusiasm to go on a cruise yourself, finish listening to the podcast, but after that, Google up some of these cruise deals, because they're quite compelling. For investors, we tend to wait until the quarter after wave season is over and look at bookings. How did the cruise ships do in terms of getting bookings for the rest of the year? How does their capacity look for the rest of the year? Is it now filled up? It's really crucial, but an interesting season native to this industry.
Flippen: I'm really interested about the different cruise stocks that are actionable for investors. It's great for consumers, you can go out there and get all these great deals right now, but I know that you've spent a lot of time digging into what's essentially the big three cruise lines in the industry right now.
Sharma: Sure. There really aren't a lot of choices if you're interested in investing in the cruise industry outside of the big three, which are Carnival Cruise Lines, Royal Caribbean (NYSE:RCL), and Norwegian Cruise Lines. Symbol for Carnival is CCL. It's a dual-listed company, so this is the symbol you want as a U.S. investor. Royal Caribbean is RCL. And Norwegian Cruise Lines, NCLH.
These are great companies as a small set. You can benchmark them against each other. So, maybe before I get into specifics, Emily, let me answer a couple of questions that you posed to me in terms of how do we determine what is a "best" cruise line. And we won't say best, maybe, with our hands to the wall, since there's only three, but maybe what defines better or a good cruise line.
So, if you're investing in this industry, you want to be careful about capacity. In other words, how many ships is a cruise company putting into the ocean each year? Here's another term that you can learn that's native to this industry -- it's called new build. A new build is simply a ship that's under construction or has recently been completed. So, what does the new build pipeline look like? If we're headed toward a recession, and a cruise company is just plunking down billions because they want to increase capacity by 25% in the next year, that might be a little bit of a red flag.
Another thing you want to look for is a high return on invested capital. Return on invested capital is a metric I know investors have heard us on Industry Focus, be it Consumer Goods or Tech or any of the others, talk about this term a lot. But it really applies well here. How good is the company at investing the capital that it has into these ships, and then getting an annualized return on that? So, we can compare return on invested capital among these three companies. We'll get into that in a moment.
And then, you want to see steady growth in net revenue yields. Net yields is an industry term, again. And I promise, that'll be the last industry term I'll throw at you guys today. But it simply means a cruise line's net revenue divided by total available passenger cruise days. So, it's a way of looking at revenue in terms of units and understanding how good a company is at having revenue divided by its capacity. You want to see this number at least exceeding the rate of inflation. So, it could be low single digits. When it's really healthy, a cruise company could be throwing off net revenue yields growth of mid single digits, or even close to high single digits.
So, those are three good parameters you want to look at in this industry when you're comparing these stocks against each other.
Flippen: I think it's so interesting, because when you laid out those three points, the first thing that came to my mind was the airline industry. Going back to our analogy for the airline industry here, there are a lot of similarities in what we look for in cruise stocks that we look for in airline companies. But the flip side is that airline companies, you get a lot of people traveling for business, a lot of people willing to pay up a little bit more, really competitive loyalty programs, and demand that isn't as cyclical as the cruise industry's, right?
Sharma: Yeah, absolutely. You alluded to something that's really interesting to me in that the capacity in the airline industry, there is a market for old aircraft. There's a secondary market. So, when Delta is finally through with one of its planes -- and they, by the way, happen to hold onto their planes longer than almost any other legacy airline -- there's always a leasing company to buy those old planes and put those in service, sell them to smaller carriers. Cruise operators build these really huge vessels, and there's not really this vibrant market when you're ready to retire a ship, that another cruise company wants to snap it up and refurbish it. So, these companies have to be extremely good at how they measure capacity growth, and they have to understand the economic cycle. And by and large, Norwegian, Carnival, and Royal Caribbean have been really good at understanding when not to overbuild.
And maybe, while we're talking about a potential snafu in terms of building too much capacity, let's look at the flip side, what might define a not-so-good cruise operator. We talked about capacity. Another is not being able to optimize onboard revenues. What Emily was referring to earlier in the program, that we get onboard and we're incentivized to spend -- if you don't do a great job at that, and especially in this day and age, if your tech onboard isn't funneling people to spend. If the app that you download, which guides you through your whole voyage, isn't telling you, "Hey, there's a special at the bar! Go now and drink! Drinks are 50% off!" you're losing a lot of revenue opportunity versus your fierce competitors.
On the flip side of some of the positives we talked about, a lower return on invested capital, one that's hovering in the very low single digits, is a yellow flag. If you have stagnant or declining net yields, meaning you're not able to increase that revenue per passenger per cruise day, that's also a bad sign. And, I'll throw out one more, which is an effectiveness at hedging fuel prices. And maybe, Emily, I'm thinking by the time we finish this podcast today, we've realized that the cruise industry is a stepchild of the airline industry. Because airlines, they have to hedge fuel all the time. And the cruise industry also has a very big both labor component like airlines, and also a fuel component, oil component. So, you've got to be able to smooth out the ups and downs of that market. And buying fuel is complex in today's world. It's often affected very suddenly by geopolitical events. We saw the bombings of Saudi Arabia's output last year. There are some new maritime regulations that all the cruise operators have to abide by this year to reduce sulfur in their emissions, which changes the type of fuel they buy. So, you have to be good at that. And if you're not, that can be a yellow or red flag as well.
Flippen: You took the time to pull a lot of really interesting numbers about Carnival, Royal, and Norwegian to compare apples to apples, to the extent that we can quickly. And the numbers are honestly really interesting. The companies themselves are more similar than I would have assumed. But there's lots of differences, what I'm noticing, in free cash flow between the three operators -- notably that Norwegian seems to be producing way more free cash flow than both Carnival and Royal. And that kind of seems to go back to what you were saying about investing, right? They're investing either in new ships, or investing in the onboard experience, leading these companies to spend a lot of money on capex. And it's really a compelling industry because of the fact that they're fighting that uphill battle of convincing people that they need to go on a cruise, versus airlines don't really need to convince people that they need to travel.
Sharma: Yeah, because airlines, as you said, they have that whole business component that's always there. There's no big business traveling contention that's going on with cruises. It would be fun and nice if everyone got money from their companies to go have company meetings for two weeks out on sea --
Flippen: There's an idea!
Sharma: [laughs] But, there is no business equivalent. And so, they have to be so careful about this capacity. Something that you mentioned to me when we were prepping for the show, Emily, about Norwegian. I know you did a deep dive into them recently. In your research into them, you were telling me that, hey, they are very careful not to just throw out new ships, and they like to upgrade their ships as they get older. And I think that's reflected in these numbers that I pulled. If you look at the trailing 12 months, while each of these companies has operating cash flow in the billions -- that is the cash flow that's needed to pay operating expenses -- what's left after you pay for your physical assets, like new ships and upgrading equipment, etc., Norwegian, at least over the last 12 months, has about $1 billion in free cash flow. Versus a little under $400 million for Royal Caribbean. And Carnival, which is going through a big upgrade cycle, they only had $46 million of free cash flow left, because they were spending on new ships and bringing those out onto the ocean. So, I found that pretty fascinating.
Flippen: It kind of leaves me scratching my head and thinking to myself, is it worth trying to pick out a single cruise stock, or do I just buy a basket?
Sharma: Yeah, this is tough, because if you look at a chart, put these three on a long-term chart, when they're close together, their performance is very similar. However, over about the last five and even 10 years, Royal Caribbean has outperformed against its peers. And that's because I think it's sort of -- if you look at the Three Bears story -- it's the one that's right in the middle. It's not as small as Norwegian, which has about $12.7 billion in annual revenue. Royal Caribbean has $28 billion. And then Carnival, which is the largest, has about $35 billion in annual revenue. So, it's between those two. It's got a slightly higher operating margin. It generates about a 20% operating margin versus Carnival at 16%, Norwegian around 19%. So, it's got some small advantages, and it's had a little bit higher growth in net revenue yields recently. So, it's outperformed its peers. I'll give you the five-year return. Royal Caribbean has appreciated about 79% versus Carnival's 30.5% and Norwegian's 31%. And that's on a total return basis, so, reinvesting dividends, although Norwegian doesn't actually offer a dividend. The other two do.
So, if you only look at the past, you might say, "Hey, I should be investing in Royal Caribbean." But based on the stuff that we've been looking at, Emily -- in fact, if you spread a lot of their financial statistics out, they're so similar. I think the future will hold that these stocks will move more in parity. If it were me, I'd buy them all in a basket.
Flippen: I guess the natural question off of that, if I can continue to press you, is, should you be invested in the cruise industry at all? So, you look at these three companies, and they all seem to be solid performers. You mentioned that Royal Caribbean in particular has been an amazing performer. And all three of them are subject to the same market forces. But is there any big tailwinds, or maybe even headwinds, that are being posed to the cruise industry right now that would make it a compelling time for investors to get involved? Or, should we continue to sit on the sidelines?
Sharma: I think it's a persuasive investment in general. We should maybe talk about the headwinds. Well, let's talk about the tailwinds first. Let's talk about what makes this a nice long-term investment, this industry. One is -- and I was surprised by this -- the long-term market compounded annual growth rate -- it's a way of measuring how fast an industry is growing every year -- is 5% to 6% for this industry, and it's projected to keep doing that for about the next 10 years. And, against a lot of other industries in the consumer goods space, that's actually a pretty fast growth rate.
Flippen: That's huge.
Sharma: Yeah. So, what it tells investors is, this is a place to look where companies can grow their market share. And I think that's very, very convincing as one reason to take a look at this. Also, we've got so many new ships and new ports. The industry is evolving very quickly. Antarctica now is a destination that isn't quite so remote and exotic as it was even five to seven years ago. There are more tours to places like the Galapagos Islands, more tours to Alaska. There are more river cruises in Europe, which have become an extremely popular part of the industry. So, there's many opportunities for these companies to grow. Just looking at Royal Caribbean, in terms of new ships, it's bringing on the Celebrity Apex, the Silver Moon, and Silver Muse in its overseas series, and a ship called the Odyssey Of The Seas. That's just one cruise line next year. None of these are overextending on their capacity, but they are giving travelers great choice in really interesting ships and experiences. So, those are two really big tailwinds there.
Just a couple of quick others. Technology, as I mentioned at the beginning of the show, it's geared toward a contemporary traveler. Ships are being designed for those who want to share their experience on social media, or even to just have an experience versus buying something. So, for this younger generation, millennials, Gen Z, who really favor experiences, ships are being designed to give you that experiential joy that you're seeking.
Finally, a tailwind that I'm interested in is the luxury component, sort of the upmarket, is attracting a lot of Asian travelers, specifically in China and India. Emily, I wanted to ask you -- you lived in China for four years. What is your take on travel, especially for the cruise industry, among that burgeoning middle class that's in, say, China and India?
Flippen: It's actually really interesting, I think, the components of Asian travel, Chinese travel in particular, that's focused on groups. Historically, the Chinese government has in a lot of ways limited the locations that Chinese people could travel. And in many places, you could only go if it was with a group. And so, not to mention language barriers, but also these self-imposed government regulations have encouraged what I experienced to be a culture of group traveling that might make that Asian market more receptive to cruises, increasingly, as they get more disposable income.
Flippen: That is really cool. That's a cultural component that I wasn't aware of. The whole aspect of how the government interacts with its consuming public is so fascinating to me. I think the Chinese are great planners, they seem to know how to keep their economy going.
You asked for the headwinds. I'm going to briefly run through some of these, which are pretty much risk factors when you're looking at this industry. So, a possible headwind as early as this coming year is, everyone knows that we're sort of overdue for a recession. The World Bank forecast for global GDP growth, it's projected to rise just a little bit this year to 2.5%. But in the U.S., we're looking at just 1.8% growth this year. And the majority of the cruise industry still is centered in the U.S. We have 50% of global passengers. So, that could hurt the industry, if we do hit a recession.
Longer term, this gradual deflation of airline tickets that we mentioned is basically a competitor for cruise dollars. So, you have to watch the popularity of that industry. And also, how the internet makes it so much easier to plan a flight and Airbnb and experiences on the ground versus what used to be more parity in the two experiences. Also, I mentioned the sulfur emissions that the International Maritime Organization is regulating. That's going to be a slight headwind for this year. Most of the cruise companies have already reported how much they think it'll affect their earnings as they comply with the standards.
But one interesting headwind that we should all think about is climate change. I believe that Hurricane Dorian this year affected all three of the cruise lines' earnings in a disruptive way. And not only this, but we see, especially in Caribbean destinations, smaller-scale weather events affecting a lot of ports. And as we grapple with the whole issue of climate change -- and I won't get political here and give my personal opinions on whether it's manmade or just a natural phenomenon, but it's here, the science supports that it's here. And this is something that the cruise companies are learning to deal with. And they are trying to come to terms with this. I'll just give you one example. Carnival has tried to become a more sustainable organization. It's switching a lot of its new ships over to liquefied natural gas, to do what they can for the climate. I think that's a win for them. Over the long term, they might have more fuel-efficient ships. And it's sort of a win in marketing terms, because younger travelers like to see stuff like that.
But, those are some headwinds you need to think about before you invest.
Flippen: I'll tell you what, I do feel more compelled today to invest in the cruise industry than I did yesterday, that's for sure.
Sharma: Cool. I want to make one last point, really quick point. In terms of when you invest, if you like a company or an industry, it's never too early to invest. You can dollar-cost average if you think maybe valuations are a bit high. All three of these companies have pretty modest forward P/E ratios, meaning they're not too overvalued at this point in time. But I would say, here's an idea for you, investors, something that Emily and I chatted about when we were prepping for the show. If you like the industry, we've already said it's cyclical. You may want to wait for a recession because everyone hates the cruise industry in a recession, and these stocks will get beat up. That would be an optimal time to buy in, and then just forget that you own these stocks for several years. You'll see a pretty handsome return.
Flippen: I love that idea. Asit, thank you again for coming on and chatting. Yeah, I feel like I've learned a lot from you today.
Sharma: Thanks so much, Emily. This was a fun conversation.
Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say hey, shoot us an email at firstname.lastname@example.org, or tweet us @MFIndustryFocus. If you're looking for more of our stuff, don't forget to subscribe on iTunes.
As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass today. For Asit Sharma, I'm Emily Flippen, thanks for listening and Fool on!