Why the Cruise Sector is Outperforming Leisure and Lodging
We’ve written a few articles about the cruise industry in the past (see links at the end), but we thought it would be interesting to show how and discuss why the sector is outperforming the broader lodging and leisure industry.
As a reminder, we like the cruise industry because it is a long-term secular share gainer within the broader vacation market. Only 10% of the American population has ever taken a cruise. Those numbers are much smaller in the other major source markets. Customer satisfaction rates are very high, driving high repeat rates. New, modern ships offer a broad assortment of amenities that offer guests a variety of experiences and which appeal strongly to group vacations and multi-generational vacations. The industry has a nice balance between repeat customers and new-to-cruise customers which will drive additional repeat business in the future.
Our thesis on the cruise lines is predicated on cruise demand outgrowing net capacity additions across the industry, thereby improving pricing and returns on invested capital. The equity story simplifies to modest capacity growth + healthy pricing growth = total revenue growth. Costs increase below inflation, driving incremental margins in the 60% range. Revenue can grow in the 10% range, while EBITDA and net income can grow at mid-teens rates or better. EPS and FCF/share grow faster from value-enhancing capital allocation (reducing interest expense and/or repurchasing shares).
Cruise companies offer consistent, best-in-class growth in revenue and earnings, but still trade at some of the lowest multiples in the sector. The table below shows some of the companies in the broader leisure/lodging industry:
Source: Bloomberg
Now, let’s look at estimate revisions, which is the easiest way to see changes in fundamental momentum over a period of time.
RCL has been the cleanest and most disciplined cruise operator over the last few years, so it is closest to the normalized trends we expect out of the sector. NCLH and CCL have had management changes which have driven some changes in operating philosophy and execution, but all the North American brands should trend toward RCL’s performance, even if they remain a bit ahead for a while. We can see steadily rising revenue estimates for 2024 (blue) and 2025 (red) since the beginning of 2022. This is what we hope to see from our companies.
Source: Bloomberg
Now, let’s compare to Marriott, which has been more uneven:
Source: Bloomberg
Marriott’s estimates for 2024 and 2025 are lower vs. the start of 2024, after rising steadily in 2022 and 2023.
What about trends in Las Vegas? Let’s look at Caesar’s Entertainment.
Source: Bloomberg
This chart shows steadily declining estimates. That business has been weakening.
Finally, let’s look at Polaris, a discretionary company that sells leisure vehicles like snowmobiles, ATVs, etc.
Source: Bloomberg
Polaris’ 2024 and 2025 estimates have been steadily declining. Again, not what we want to see.
How can we explain why the cruise sector is gaining strength while other areas of leisure and lodging are weakening? Is there something exceptional/one-time happening in the cruise sector? The short answer is no.
This is what disruptive growth is supposed to look like while it’s happening. Cruising is not benefiting from revenge travel anymore. The sector is gaining share within the vacation market by bringing unique experiences and exceptional value to customers. Even in a choppy overall consumer environment, as evidenced in the revenue revisions above, these companies are pulling wallet share and engagement in their direction – and they have a long way to go with only 2% of the global vacation market.
The cruise companies are vertically integrated and serve captive customers once they are onboard. They design and own their ships, they manage diverse channels for demand creation, they manage prices and yields dynamically, and they manage nearly all operations onboard (and many experiences on shore). They have the ability to engage with customers from the time those guests book all the way through the whole cruise itinerary. Cruise companies can push customers packages, bundles, and offers across that entire timeline to optimize pricing and yields.
On top of all their vertical capabilities, they are competing in a vacation market that has seen dramatic price inflation, which makes cruise a great value on a comparative basis. Going to a nice beach resort easily costs over $700/night per room for a 4-star experience. Cruising offers a compelling and unique experience at a lower price – a price that includes high-quality basic food and beverage. There are many reasons for them to win share.
We’ll close with some comments from cruise management teams as 2024 has progressed.
“What transpired over the past 3 months was even better than our already elevated expectations. Our brands are stronger than ever and demand for our vacation experiences continues to accelerate.
We are leading the way in delivering a lifetime of incredible vacations for our guests with our exceptional and leading portfolio of brands, innovative and differentiated ships, exciting and exclusive destination experiences and leading commercial capabilities. The opportunity is very large and very exciting as we seek to take share from the rapidly growing $1.9 trillion vacation market.
Our formula for success remains unchanged. Moderate capacity growth, moderate yield growth and strong cost controls lead to robust financial performance and long-term shareholder value.
”
Next, we’ll hear from Harry Sommer, CEO of NCLH. He responded to the following question.
Question: “Marriott this morning talked about seeing a slightly lower ancillary spend across the system. The U.S. was implicated in that. Again, broad-based, but slight. You guys have your own real-time cash register. Are you seeing any wobbles or waivers in that onboard spend over the last few weeks? Sorry for the short-term question, but it's topical.”
“Sure. I’ll give you a short answer and then a longer answer. So the short answer is no. We are seeing no, absolutely 0 decrease in onboard spend. I think we mentioned in our prepared remarks, in fact, that the preselling of onboard is actually up considerably over the prior period that we comped to.
The slightly longer answer is you need to keep in mind a couple of factors. The huge value gap between hotel ADRs and cruise line yields. I think at our Investor Day, we referenced the 40% value gap, which really still means we have tremendous runway to go to catch up the hotels. We consider that a long-term tailwind for the company.
And also the fact that because our bookings pattern is so much further in advance, we have lots of opportunities to engage with our consumer and discuss with them all the value of being on our ship. I will give you a little bit of the fact that the people are in our product the whole time, unlike a hotel where people come and go. They are sort of are on the ship for extended periods of their vacation, which gives us a little bit of a tailwind there as well.
So overall, the short answer is no cracks, no deterioration. If anything, it continues to be strong and more long term, I think there are fundamental things that work in our favor that make our business quite a bit more resilient than the hotel on the ancillary/onboard spend category.”
Finally, we’ll hear from Josh Weinstein, CEO of Carnival Corporation answer the following question:
Question: “And then just a follow-up, maybe, Josh, if you could address the broader land-based leisure demand environment, what we're seeing elsewhere is not what cruise has seen, we kind of see sort of steady, slow somewhat softer normalization. We don't get any of that from you in your commentary today. I guess, we understand why it's happening, but if the rest of the world is narrowing a little bit toward narrowing your, let's say, your gap from the top. Do you see any of that affecting your consumers' behavior and willingness to spend and sort of pricing sensitivity?”
“We are still a remarkable value to land-based alternatives. And maybe land-based is softening because we’re doing better. Who knows? You have to ask them that. I can’t tell you their business. But we have a tremendous value. We are doing a better job of getting our word out, better marketing, more eyes on the industry, more eyes on us. Our new-to-cruise this past quarter was up about 17% year-over-year, that’s not by accident, that’s because our brands are really focused on driving that demand profile. So I don’t have a crystal ball, and I can’t tell you what the world is going to look like a year from now, 2 years from now.
But I can tell you if we keep focusing on commercial execution and doing the right things and doing them better, then there’s a long runway because the one thing that’s never been a question is can we execute on board and deliver a great experience. And that’s always been the case. It’s just a matter of how we convince people to come with us who have never have, and I think we’re doing a good job on that.”
Conclusion
It’s easy to identify disruptive growth retrospectively – we just have to see how much faster companies grew compared to their competitive set over a multi-year period. It’s more challenging to identify accurately it in real-time. We think the North American cruise sector is exhibiting characteristics of disruptive growth, but it is expressed over a longer arc of time due to the limited new capacity that can be brought to the market in any given year. Disruptive growth in this industry translates into healthy, above-inflation pricing trends, steady capacity additions, and steady EPS and FCF/share growth.
If you’re interested in reading more on the cruise sector, please read our prior posts:
