Carnival Corp (NYSE:CCL) and Royal Caribbean Cruises (NYSE:RCL) may offer a similar product, but small differences make one a much better long-term investment than the other. The product economics of the cruise business are not great, but both companies have the potential to create value for shareholders in future years. Let's take a look at which one offers the best value for long-term shareholders.
Sizing up the fleets
Carnival and Royal Caribbean are the two largest cruise companies in the world. According to CruiseMarketWatch.com, Carnival has a 48% global passenger share and a 42% global revenue share. Royal Caribbean's market share is about half of Carnival's, with a 23% passenger share and a 22% revenue share.
As you'd expect, Carnival's fleet is more than twice the size of Royal Caribbean's. Carnival operates 101 cruise ships and Royal Caribbean operates 41 cruise ships. However, Royal Caribbean managed to serve 119,000 passengers per ship in 2013, while each of Carnival's ships served only 99,600 passengers for the year despite having a higher occupancy rate. This is because Royal Caribbean uses bigger ships than Carnival, so it fits more passengers on each ship.
Royal Caribbean's ship size advantage also gives it a revenue advantage. Larger ships allow it to pack on more services and amenities that passengers can purchase. Last year, Royal Caribbean generated $63 per person per cruise day from onboard amenities. Carnival generated just $47 in onboard revenue per person per cruise day – 25% less than Royal Caribbean!
Royal Caribbean also averaged a slightly higher ticket price in 2013 -- $161 per passenger per cruise day versus Carnival's $154 daily rate. This means that Royal Caribbean generates more revenue per passenger per cruise day than Carnival – so its ships are more efficient at generating revenue than its larger rival's.
Low-cost operator wins the day
On the surface, it looks like Royal Caribbean is the better company. In an industry that confers no pricing power to any company, the most efficient operator ends up on top. Carnival generates less revenue per ship than Royal Caribbean, but it earns a higher profit. Carnival averaged a 37.1% EBITDA margin from 2004 through 2013, excluding fuel costs. That was 6.2 points higher than Royal Caribbean's average.
Carnival generated $15.4 million in revenue in 2013, or $154 million per ship. At a 37.1% EBITDA margin, Carnival would average $57 million in EBITDA per ship, excluding fuel costs. Royal Caribbean leveraged its larger ships to generate $194 million in revenue per ship. At its 10-year average EBITDA-plus-fuel-costs margin, Royal Caribbean earned $60 million in EBITDA-plus-fuel-costs per ship – barely edging out Carnival.
However, reality sets in when you look at profit per ship as a percentage of cost per ship. Carnival's ships are less expensive to build and maintain than Royal Caribbean's ships. As of the end of fiscal 2013, Carnival had spent $42.4 billion to build and maintain its fleet – about $420 million per ship. Royal Caribbean spent $550 million per ship to build and maintain its fleet. Its latest ship, Quantum of the Seas, is an enormous state-of-the-art cruise ship that will increase the company's overall passenger capacity by more than 4% and is expected to cost nearly $1.1 billion.
You don't need a calculator to see that Carnival's $57 million EBITDA per ship generates a higher return on investment than Royal Caribbean gets on its ships. Differences in fuel costs between the two companies can narrow or widen the gap in any given year, but Carnival maintains a long-term advantage in ship return on investment.
A durable advantage
Only two important observations need to be made to show that Carnival is a better long-term investment than Royal Caribbean: (1) Carnival can maintain its cost advantage and (2) Carnival's cost advantage allows it to maintain its market share.
Carnival will likely continue to generate a higher profit margin than Royal Caribbean due to sheer size. Carnival's scale gives it lower per-unit costs on everything from food and beverages to transportation costs. For instance, Carnival's commissions and transportation costs were just 19.8% of revenue last year, compared to 23% of revenue for Royal Caribbean. These expenses include travel agent commissions, the cost of airfare sold through the cruise companies, port fees, and local taxes. These seemingly small advantages give Carnival a decisive advantage in profitability.
Since Carnival's size should allow it to maintain its cost advantage over Royal Caribbean, the company should be able to maintain its market share advantage as well. Carnival generated $2.8 billion in cash from operations in 2013, while Royal Caribbean generated $1.4 billion. With the cost of cruise ships running from $500 million to over $1 billion, Carnival clearly has more cash to spend building new ships and maintaining its fleet.
Royal Caribbean is already stretching its financing capacity to the limit. In addition to its $1.1 billion Quantum of the Seas project, the company is building three other ships to add to its fleet. All told, Royal Caribbean will spend an average of $1.4 billion per year through 2018 to build the new ships and maintain its fleet. Meanwhile, Carnival has committed to spending an average of $1.6 billion per year on shipbuilding over the next three years.
Carnival could outspend Royal Caribbean by even more if it needs to expand capacity to maintain market share. Not only does Carnival generate more cash from operations than Royal Caribbean -- the former generated $2.8 billion in 2013 compared to the latter's $1.4 billion -- it also has more free debt capacity than its smaller rival. Carnival's debt-to-equity ratio is just 0.39 , less than half that of Royal Caribbean . As a result, Carnival should be able to maintain a long-term financing advantage over Royal Caribbean.
Size matters in the cruise industry. Carnival's size gives it a cost advantage that allows it to generate a higher return on investment than its smaller competitors. In addition, the company has a greater ability to expand capacity due to its higher cash from operations and lower debt burden. As a result, Carnival looks like a better long-term investment than Royal Caribbean.
Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.