If you're interested in gaining exposure to the global vacation industry but want to venture beyond the traditional hotel, airline, and travel booking giants, then cruise line stocks might be just what you're looking for. Cruises enjoy the same benefits from positive long-term trends shaping the wider luxury travel industry, including economic growth and rising incomes, but cruise ships aren't as susceptible to competition from smaller rivals and the industry economics are more favorable than in the airline space.
But there are a few factors investors should know about the cruise ship business before they begin buying stocks in the sector. Below, we'll take a comprehensive look at the industry, the biggest cruise line operators, and the metrics that matter most to a cruising business. Arming yourself with everything you need to make smart decisions about riding the cruise line wave will help you grow your money and diversify your portfolio.
Image source: Getty Images.
What is the cruise line industry?
Cruise lines are part of the travel and vacation industry, which means they compete with each other, and also with land-based hotels and resorts. The broader global addressable market is massive, with estimates pegging total travel spending at over $1.6 trillion in 2018.
The cruise industry only covers a small subset of that huge annual spending pie, but it has several characteristics that support unusually strong and profitable growth, including high customer satisfaction. Cruise guests typically rate their vacation experiences more positively compared to land-based hotel trips. Some of the benefits that cruisers cite are stress-free travel to several destinations without needing to pack and unpack and the peace of mind that comes with all-inclusive bookings that cover food, lodging, and entertainment.
There are many tiers of cruising options, ranging from value to premium to ultra luxury, but the industry's most popular trip categories tend to cater to a wide range of demographics and income levels. Ships are packed with onboard entertainment for kids and for adults, food choices that span from pizza by the pool to premium restaurant table service, and cabin offerings ranging from sparse, windowless rooms to expansive suites with wraparound decks. On average, a seven-night cruise costs around $1,500 per person, including the ticket fare and all the onboard extras. But the total bill can reach many multiples of that price if you opt for the bigger stateroom, nicer amenities, and the more luxurious ships in the fleet.
Other characteristics that set cruise trips apart from traditional hotel-based vacations include a competitive value proposition and the fact that ships, by virtue of their mobility, can change itineraries or move to different launch cities as demand changes. A hotel company doesn't have that flexibility.
Despite these benefits, cruising remains a relatively small player in the wider travel industry, with an estimated 3% of the U.S. population taking such trips in a given year. Most cruise companies believe that metric is good news since it points to a long runway for potential growth both in developed markets like the U.S. and in emerging markets like China, where disposable income is rising quickly. The global industry carried roughly 26 million guests in 2017 compared to 24 million in 2016 and 23 million in 2015. An investment in this niche starts with the assumption that these numbers will continue climbing over the long term even if recessions briefly send them lower.
What are the biggest cruise line stocks?
The three biggest cruise line stocks are Royal Caribbean (NYSE: RCL), Norwegian Cruise Line (NASDAQ: NCLH), and market leader Carnival (NYSE: CCL). Let's take a closer look at each of these companies.
Berths (Cruise Cabin Capacity)
Norwegian Cruise Line
Berth is a measure of capacity reflecting double-occupancy cabins. Figures are for the 2017 fiscal year.
Carnival is by far the industry's largest player, with its 103 ships accounting for roughly half of the world's berths, or cruise cabin capacity. The company operates 25 vessels in its core Carnival brand that typically run vacations lasting between three and eight days, mainly to the Caribbean from U.S. ports along the East and West Coasts as well as the Gulf. Carnival owns several other cruise franchises, including Princess Cruises, Holland America, and the ultra-luxury Seabourn.
In its most recent complete fiscal year, the company generated $17.5 billion of revenue, which translated into $2.8 billion of profit. The sales and earnings figures were each up 7% from the previous year, reaching record highs. Carnival's current dividend yield is about 4%.
The second-place cruiser Royal Caribbean operates 50 ships through its Royal Caribbean, Celebrity, and Azamara Club brands. It services many of the same destinations and home ports as Carnival, and its biggest terminal is in Miami, Florida.
Royal Caribbean booked a record $8.8 billion in revenue in 2017, up 3% from the prior year. Profits also set a new high mark, too, jumping 24% to $1.63 billion, as return on invested capital crossed 10% of sales from 5% a few years earlier. The company pays out a dividend that translates into a 2.4% yield.
Norwegian Cruise Line
With 25 ships carrying 50,000 berths, Norwegian Cruise Line is a distant third place in terms of annual guest capacity. But its relatively small footprint makes it the fastest-growing cruise operator, as its plans to introduce nine new ships over the next few years should lift its berth level to 72,000. Norwegian Cruise Line owns the Oceana and Seven Seas franchises in addition to its namesake brand. These vessels tend to target more premium segments of the market with some services, like a 180-day trip, that only smaller cruise operators can provide.
Norwegian Cruise Line generated $5.4 billion of sales last year, up 10% from the prior year. Net income jumped 20% to $760 million, and the company does not pay a dividend.
How do cruise lines make money?
Cruise lines generate about 70% of their revenue through ticket sales, with the remainder coming from various onboard products and services including alcoholic beverages, shore excursions, specialty restaurants, casino gaming, and gift shops.
Like most vacation businesses, it's a seasonal enterprise, with the highest demand occurring in the summer months in the United States, where about 50% of global cruise volume begins.
Cruising, like any vacation activity, is highly dependent on overall economic growth. As a discretionary purchase, it's one of the first things that a consumer cuts back on during tough times. Thus, the industry tends to do well during expansions, while growth slows or turns negative during recessionary periods.
According to Carnival, two demographic groups are key to the industry's long-term growth. The baby boomer generation of folks in or near retirement tend to take cruises as a convenient all-in-one vacation package. Meanwhile, the younger and fast-growing millennial demographic also has a positive view of the industry.
Image source: Getty Images.
The key variables that feed into sales growth and profitability include ticket prices, ticket volume, and cruise costs. At the most basic level, a cruise line's annual earnings simply reflect the difference between cruise expenses and the income the company receives from guests. Ideal operating environments, like the ones cruise lines saw in fiscal 2016 through 2018, involve rising demand and higher average pricing, with both metrics outpacing the growth in cruise costs like fuel, food, and labor.
There's a finite global demand for cruise trips each year, and if capacity outstrips that figure, then profitability could suffer. One of the key challenges for any cruise business involves taking the right approach toward expanding its fleet. Compounding this problem is the fact that it takes several years, and lots of capital, to deliver a new ship. Industry conditions can change significantly over that time. A cruise line that overestimates demand will have to cut prices to keep ships running near capacity. If they miss on the down side, it will have to turn away guests and forfeit all the revenue that would have come from the sale of that ticket, and the add ons that traveler might have purchased while on board.
The cruise giants have flexibility when it comes to juicing demand. They each offer a loyalty program that aims to make the most out of repeat vacationers. The companies run pricing promotions, particularly for dates in the distant future, so they can secure that booking volume.
Cruise companies are constantly remodeling and upgrading ships to keep up with shifting consumer trends, too. Recent additions in the Carnival fleet include new water slides and better onboard internet capabilities, and Royal Caribbean is pouring millions of dollars into building a new state-of-the-art terminal in Miami.
What metrics should cruise line investors follow?
The key growth metric in the industry is net revenue yield, which describes the change in revenue per average room per day after stripping out the impact of foreign currency moves. The metric is similar to the revenue per available room, or RevPAR, which is used in the hotel industry. Net revenue yield includes any change in occupancy levels, ticket prices, and onboard spending, and so it represents the single best way to judge whether a cruise operator is delivering more value to its guests and translating that success into higher sales. Net revenue yield combines with capacity expansion to produce essentially all of a cruise line's growth potential.
Publicly traded cruise lines report expenses to investors in the line item called "net cruise costs," which includes the costs of everything it takes to deliver a cruise experience, from food to labor to security. It is often reported both with and without fuel because, while an important part of its expenses, swings in fuel prices can cloud the earnings picture. The gap between net revenue yield and cruise costs tells an investor how profitable a cruise line is, and whether that profitability is rising or falling over time.
Cruise line stocks all publish their return on invested capital, which is a key measure of efficiency for any business. Since these companies have to direct lots of cash toward long-term investments like new ships and fleet upgrades, this metric is critical for evaluating management's capital allocation skills.
It's also worth keeping an eye on leverage, since the cruise ship business is capital intensive, meaning industry participants typically carry lots of debt. If these liabilities grow too high, then earnings could suffer under the weight of hefty interest expenses. Ultimately, the entire business could be threatened if a cruise giant enters into a cyclical downturn while also burdened with an overwhelming debt load.
More generally, investors will see cruise companies use terms that aren't specific to its industry, including the following:
Fiscal year: This is the company's definition of a year that's comprised of four quarters. A fiscal year is roughly the same length but usually differs in start and end time from the actual calendar year.
Booking volume: This refers to the number of tickets ordered in a given period. While passenger count is backward-looking, booking volume gives a glimpse of future demand for trips that haven't yet taken place.
Dividend yield: Most cruise companies pay a steady dividend and the dividend yield refers to the amount of cash payment per share as a percentage of the stock's price. A $100 stock that pays a $5-per-share annual dividend, for example, would have a dividend yield of 5%. Investors can reinvest these dividends back into the cruise stock to grow their position.
What are the risks to cruise ship stocks?
The single biggest risk to investing in a cruise line stock is tied to economic downturns, because a weakening economy causes demand for vacations to fall, leading to smaller sales volumes, lower booking volume, and reduced ticket prices. Cruise giants have a bit more flexibility here than a regional land-based hotels does since they can relocate vessels to areas of the world that are growing more quickly. However, they're still exposed to economic slumps, especially in the U.S. where most cruise businesses operate.
The cruise business is also highly susceptible to extreme weather events, particularly the hurricanes that hit the Caribbean during late summer. The occasional strike from one of these powerful storms can produce minor write-offs, as cruises are canceled or cut short. But widespread damage to ports, like what occurred in the wake of 2017's hurricane season, threatens bigger disruptions that could last several years. Demand for Caribbean cruises fell after the devastation of that hurricane season and still haven't fully recovered as of early 2019.
Fuel costs make up a significant portion of a cruise trip's overall cost, and that fact means cruise companies are susceptible to big swings in fuel prices, just as airlines are. A sustained surge in the cost of oil will crimp profitability in the short term, at least until the company can offset it over time through rising ticket prices.
Another risk worth watching is the niche status of the industry as a whole. All the cruise ship capacity in the world just amounts to about 2% of the world's hotel room capacity. Therefore, a big part of the investing thesis relies on these companies finding ways to boost demand for this vacation option beyond what they've been able to accomplish to date.
Finally, a critical difference between a cruise and a land-based hotel is that guest health is a heightened concern during a cruise experience. Vessels are traversing open sea, after all, and so the risk of a mass casualty event is always present. Meanwhile, cruise ships, by virtue of their tight contained spaces, can quickly spread public health outbreaks of viruses. Any outbreak event or loss of life on a cruise vessel would hurt the business and could threaten the growth rate of the wider industry if it causes vacationers to question the safety of this trip option.
A few notable recent incidents include an engine fire on a Carnival ship in 2010 that cut power for several days so that guests had to eat rations and endure reduced toilet access. The company had just a few months earlier faced a flu-type virus outbreak on a different ship that sickened hundreds of guests. Carnival's stock suffered short-term pullbacks during the immediate aftermath of these events, but neither one impacted its broader growth rate.
How do you invest in cruise line stocks?
The cruise ship industry isn't large enough to offer broadly diversified investing options such as index funds or exchange-traded funds (ETFs), so investors who want exposure to the sector must choose among the public companies.
Carnival is the industry leader and so it benefits from scale advantages unmatched by rivals -- including a bigger advertising budget and a more flexible fleet. The cruise giant has enjoyed record operating results in each of the last three fiscal years. Carnival is also the most generous when it comes to capital returns, with its annual dividend currently yielding over 4%, compared to 3% for Royal Caribbean and Norwegian Cruise Line's no dividend.
There are good reasons to consider a Royal Caribbean investment, including the fact that its annual earnings pace doubled in the three years ended in 2017 while return on invested capital blew past 10%, up from 6% the previous period. Royal Caribbean has enjoyed healthy pricing and volume growth in 2018, and anticipates 2019 to be another record year.
As for Norwegian Cruise Line, its smaller footprint and lack of a dividend make it a different kind of investment than Carnival and Royal Caribbean. Its market-leading growth opportunities should boost its capacity by 25% over the next few years. Norwegian Cruise Line also has room to become more efficient as it expands, which should help its return on invested capital reach closer to the 10% reached by its peers; currently it's 7%.
Let's take a trip
Cruise ship stock valuations are highly vulnerable to changing investor predictions about economic downturns. Recently, spiking concerns about a potential recession have produced attractive discounts for the shares. All three management teams have predicted another record operating year in 2019. Whether cruise giants bounce back quickly depends on where global growth rates end up, compared to the expansion rate of industry capacity.
Over the long term, Carnival, Royal Caribbean, and Norwegian Cruise Line stocks each appear well positioned to benefit from rising global vacation demand. The expansionary years of 2016, 2017, and 2018 demonstrated that cruise stocks can generate robust earnings growth during boom times, and these gains could accelerate as the companies find more ways to satisfy their guests with unforgettable vacation experiences.
Yes, their businesses will certainly take steps backward during cyclical downturns, just as its hotel and airline peers do. Assuming the cruise ship experience continues to attract world travelers, there should be room for the industry's biggest players to significantly expand their businesses in the coming decades. That would produce fertile ground for solid investor returns -- assuming you're willing to hold on through the inevitable ups and downs of owning shares of a business that has shifting fortunes, ebbing and flowing with the wider economic tides.
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