Why Royal Caribbean’s newest ship represents a critical test for the cruise industry
By Brian From The Daily Brian
Royal Caribbean was founded 45 years ago and its first ship, the Song of Norway, embarked on its maiden voyage in 1970. Today, the company operates 41 ships across six brands — Royal Caribbean International, Celebrity Cruises, Pullmantur, Azamara Club Cruises, and CDF Croisieres de France — and ranks as the second-largest cruise ship company in the world. According to Goldman Sachs, Royal Caribbean controlled 22% of the cruise industry market in 2013, trailing only Carnival Cruise Lines, which is the dominant player in the industry with a 47% market share. Together, these two companies basically form a duopoly in the cruise industry — the next largest competitor, Norwegian Cruise Lines, will only hold a 7.5% market share by 2016; the remaining 22.5% is split among all the other companies in the industry.
From a business perspective, the industry is decidedly low margin, meaning it generates massive revenue but the costs are so prohibitive that the profits are low by comparison. In 2013, for instance, Royal Caribbean generated $8 billion in revenue but only $474 million in net income, which equates to a roughly 16.8% profit margin. By comparison, in Carnival’s fiscal year 2012, the most recent for which data is available, the company generated $15.4 billion in revenue and $1.3 billion in net income for a profit margin of 11.8%. Norwegian in 2013 recorded $2.6 billion in revenue and $103 million in net income, for a profit margin of 25.2%, meaning that although Norwegian is decidedly smaller than Royal Caribbean or Carnival it is actually operates its business more profitably. Similarly, though Carnival is the industry’s biggest player, it is the least efficient from an operational standpoint.
Quantum’s launch is important for the industry because it will serve as a litmus test to determine whether it can increase margins on ticket pricing. One of the biggest misnomers of the cruise industry repeated often but inaccurately, is that tickets are priced at cost and profits are derived via onboard spending. This is not at all true. In reality, the biggest driver of profits on cruise ships is the ability to increase ticket prices, which is something the industry has been essentially unable to do since the financial collapse of 2008. Indeed, more than any negative publicity surrounding “poop ship,” norovirus, or even sinking, what has taken the biggest toll on cruise ship performance are things utterly out of its control, such as the Arab spring, the tsunami in Japan, and, most impactful, the recession of 2008.
Roughly speaking, the revenue breakdown for cruise ships is 75% for tickets and 25% for onboard spending. Of Royal Caribbean’s $8 billion in revenue last year, for instance, $5.7 billion came from ticketing, and the remaining $2.2 billion came from onboard spending. But none of the categories of onboard spending, which include beverages, gaming, dining, retail, and shore excursions, approach 10% of the company’s aggregate revenue base.
What that means, essentially, is that for Royal Caribbean and others to make money they need to increase ticket prices. Problem is, in order to fill capacity on ships after the recession, the industry cut prices so deeply that people in the market for a cruise vacation are now conditioned to expect discounts instead of pay premiums.
“There have been very good deals out there for the consumer, well below the value they get from a cruise vacation,” CLIA’s Duffy said. “The industry has kept prices down for longer than other parts of the travel industry. Consumers are pretty smart and they do get trained for certain behavior.”
Nearly 40% of the cruise industry’s bookings are made between January and April, in what is known as “wave season.” Royal Caribbean executives have said that sales during this year’s wave season were “normal,” which Nomura Securities analysts described in a research note as marking “a substantial improvement from the past two years.” The company does not break down bookings by brand or ship, however, and regarding advanced reservations for Quantum specifically said only that “consumer response has been extremely positive.” Goldstein, the president of Royal Caribbean, elaborated a bit more in an interview, saying that 2014 will market the fifth consecutive year that revenue per guest per night will increase.
“It’s been a steady upward climb,” said Goldstein, “but the trough was so deep that we are only now beginning to get to parity with 2008.”
But not all of the discounting can be blamed on external events, some of it has also been self-inflicted. Over the last decade, cruise ship companies have expanded the number of ports to allow people to drive to ships rather than fly, which many of its core customers have been reluctant to do since 9/11.
“Retirees don’t want to fly anymore,” said Monica Smith, an agent with AllTour Travel in Manhattan. “They don’t want the hassle. You can take a cab to the ship and don’t have to deal with security or baggage constraints.”
New ports have opened in cities ranging from Charleston, S.C., and Galveston, Texas, to Seattle and San Francisco. While this has made cruising a more popular and less expensive vacation option since most consumers no longer have to pay for airfare, it has also helped keep pricing levels depressed by raising the expectations of affordability. (The move is rich with irony since cruising grew as a vacation option for the middle class in tandem with the airline industry expansion in the late ’70s.)
Investors, however, appear encouraged that the company will be able to get pricing. Royal Caribbean’s stock lately has been trading in the low- to mid-$50 per share range, continuing its steady climb from the less than $10 per share levels it sunk to after the recession to its highest price in years.
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