The cruise vacation industry is a high-profit market, with scarce competition due to its high barriers to entry. Thus, 75% of the market share is run by Carnival Corporation (CCL) and Royal Caribbean Cruises Ltd. (RCL), the latter being second-largest company in this vacation segment. Nevertheless, with 41 operating ships and 95,000 berths, this company is slowly recovering from an intense 2012 and 2013 fiscal year. So, why did investment guru Julian Robertson (Trades, Portfolio) add another 70% of this cruise line’s shares to his portfolio? Let’s take a look.
Scale Advantages and Brand Portfolio
This cruise vacation industry player is the second most popular pick among the leisure-seeking and retired population. With a potential domestic market of 133 million, only 20% of which have already indulged in the cruise-ship experience, this underpenetrated industry has more than sufficient room for growth. And Royal Caribbean Cruises owns an ample brand portfolio for supplying demand. These include Royal Caribbean International, Celebrity Cruises, Pullmantur, Azamara Club Cruises and CDF Croisieres de Frances, along with a 50% joint venture in TUI Cruises (Germany). All these brands unite innovation, quality of ships and service, a broad variety of itineraries, and choice of destinations as their key qualities.
Furthermore, the company’s 95,000 berths are spread all over the world, and the high paced expansion in emerging markets like Asia and South America, are bound to act as catalysts for the future stock price, which is currently trading at $48. With an underpenetrated market, that simultaneously has the highest satisfaction rates and percentage of repeat client in the vacation industry, Royal Caribbean’s upside potential remains significant. The firm’s scale advantages might generate high costs on capital, but with cruise ships worth a minimum of $500 million, it’s almost impossible for new market entrants to succeed. In addition to this, the cruise-operator has done a successful job at maintaining its customer loyalty.
A Rough Year’s Effect on Valuation
Cruise companies have had a rough couple of past years, with the geopolitical environment headlining risks in 2011, and Carnival Corporation’s unexpected accidents in Europe and the Caribbean marking a difficult 2012 and 2013. With a steep downfall of customers' trust weakening the European market, Royal Caribbean redeployed its ship fleet towards other regions, thus cushioning the downside effect on pricing. However, several key metrics suffered under the overall mistrust in the industry, with returns on equity, operating margins and returns on capital closing fiscal 2012 in losses. Nevertheless, the company managed to retrieve its growth potential in quarter four of 2013, and expectations for 2014 are looking bright.
The company’s cash flow of $648.3 million, for one, will increase over the long term as debt gets paid down and capital spending slows. The current 10% operating margin will reach 14%, as the firm gains cost leverage through more efficient fuel consumption and customer loyalty regains strength. The current revenue growth of 8.60% is still above the industry average of 5.50%, but pricing power and marketing strategies should be able to push the $8 billion gain further in the future. On the other hand, the company’s current sluggish return on capital of 4.6% should be able to reach management's intended double-digit ROIC in the long term, via better management of expenses and debt payments.
I feel bullish that this cruise operator will prove profitable in the long term future, given the capital-intensive nature of the industry. Finally, this may not be the best time for a market entry, since the company’s shares are currently trading at an outrageous 589% price premium relative to the industry’s average.
Disclosure: Damian Illia holds no position in any stocks mentioned.