This year has not been all fun and games for Carnival Corp.
But fear not fellow Fools, now is not the time to abandon ship. Carnival's wonderful business model is still intact.
You vacation wrong
I used to think a cruise ship is where rich retirees spent their twilight days. Turns out that's not entirely true. Cruising is actually cheap, really cheap, in comparison to land-based vacations. (The average age of a cruise passenger is still 50, although that's declining as well.)
Exhibit A: Carnival is offering a 16-day cruise from Barcelona, Spain, to Galveston, Texas, with day stops in Spain, the Canary Islands, and the Grand Turks, for $699. That's $43 a day, with food, lodging, regional transportation, and transportation stateside included in the price.
Try vacationing from land in Europe for $43 a day, I dare you. Heck, try living in New York or D.C. for $43 a day.
Even the more expensive cruises from Carnival's Princess Cruises or Royal Caribbean's
No wonder the number of passengers has grown annually at 5.3% worldwide, and 12.1% outside of North America, since 2005.
What's even more amazing -- and far more important from an investor's perspective – is that Carnival makes money doing this. Lots of money.
In 2010, Carnival made $2 billion, which was more than Marriott International
Heck, even in 2008, when oil hit $145, Carnival still made $2.3 billion. (And while hotels don't need oil, they have land to buy/mortgages to pay.)
The margins tell the tale: Carnival's operating margin was 16.2% in 2010, whereas Marriott's was 5.9%, Host Hotels and Resorts' was 5%, Hyatt's was 3.1%, and Wynn Resorts and Las Vegas Sands clocked in at 14.9% and 17.2%, respectively. The comparison isn't exactly equal because Marriott manages/franchises hotels while Las Vegas Sands and Wynn primarily operate on gambling, but if anything I would expect that to benefit them in comparison to Carnival.
So how is Carnival able to beat hotels on price while earning higher margins?
The most likely explanation, for my money, is the ability to price discriminate. That's the ability to charge what each individual customer is willing to pay.
You see, hotels are stuck in a difficult dilemma. If they price too high that will scare away leisure travelers. If they price too low, they won't be able to exploit the business travelers that need to travel. As a result, hotels strike an unhappy compromise: They price higher than the market price to capitalize off business travel, but that leaves them with empty rooms. They turn to priceline
For example, Hyatt's occupancy rate in 2010 was 70.9%. So on average, about a third of rooms were empty and not generating any revenue.
Carnival doesn't have the same dilemma. Carnival knows that nobody needs to take a cruise. Hence they price their ships for maximum occupancy without regret. In 2010, occupancy was 105%. In the depths of the Great Recession, occupancy was still 105% (more than two to every room). In order to create such high demand, it offers cheap rates for consumers. However, once on the ships, consumers typically buy additional services and goods that the company can sell at a substantial markup. This evening-out effect helps pad the company's overall margins.
At the same time, Carnival can still capitalize off of travelers who'd be willing to pay more. Those customers can choose premium Carnival brands like Holland America, Princess, or Seabourn, cruises that charge around $100-$400 a day. Those travelers aren't likely to trade down because their choice of cruise brand plays an enormous role in their vacation experience.
Everything from the food they'll receive, to the places they'll go, to the people they'll meet, are enormously different on a Seabourn cruise as opposed to a Carnival-brand cruise.
By contrast, Marriott and Ritz Carlton both take you to the same Manhattan.