Cruising Economics
Singapore is a unique place in many ways, a city-state with no natural resources, but still, it boasts one of the highest per capita incomes in the world. A multicultural melting pot that has some of the best living conditions anywhere in the world, while maintaining its title as one of the greenest cities globally. However, during the pandemic it has adopted another unique title – it boasts the only functioning cruise operated by Royal Caribbean (“RCL”) globally. In fact it may be one of the only cruises operating anywhere (by the major operators), with searches on Carnival Cruises and Norwegian cruises showing 0 results for any sailings in March.
Branded the “Cruise to Nowhere” Royal Caribbean’s Quantum of the Seas takes Singapore residents on a two to four night journey to the South China Sea, stops in the middle of the water, and comes right back. Now, this might not sound like much, but as most Singaporeans have not left the city in over 15 months, the offer was quite appealing to many, yours truly included. So my wife and I signed up for a three night cruise (which was heavily discounted to attract kiasu Singaporeans like us) and we actually had a wonderful time. Further, the operations were seamless, and the staff did a great job enforcing social distance and constantly sanitizing. Plus, all travellers were required to have a covid-negative test result before boarding (paid for by RCL), thus the risk of getting covid on-board was infinitesimal.
Not having done any of these all-inclusive trips (food is included in the price) as an adult, I was sceptical if the ‘value’ the trip provided was real, or if we would we be met with sub-par services/food. This scepticism was proven to be unfounded, as the ship was top-class, the food was actually pretty decent, and the alcohol potent. Overall, we found it to be a great way to travel, as a lot of the stress of where to eat, how much to budget, etcetera, was pleasantly taken out of your hands. You had several choices of entertainment at your fingertips and lots of free add-ons throughout (including all the soft-serve ice cream you would ever want!).
This got us thinking; is there something to this business model? After the world reaches herd-immunity, will we see people re-test their sea legs and hop on-board major cruise lines? And would this attract investment – after all, from its 2008 lows RCL delivered a 22x return to shareholders over the next 10 years. So below we’ll take a look at the appeal from the customer’s point of view to see if there is a reason for the attraction, and then we’ll take a look at how the economics might work for the cruise-line operator. Do note – this is far from a full-blown thesis as the numbers below are very rough, and don’t take into account RCL (and other cruise operators) enormous debt loads or seemingly expensive valuations. So as usual – this is not investment advice, and in fact we wouldn’t take this is as anything more than an overly-analytical way to holiday plan :)
Why customers love it:
There are qualitative reasons why people love cruises, some of which we’ve listed above. But what struck us when we went on the cruise was just the sheer value of the package. Now granted, we were offered a deep discount, but even without it, the package would have made economic sense. To understand why – let’s put some numbers behind it by comparing a cruise trip (we’ll use RCL as the example) versus a generic international trip. We’ll assume the traveler is from Singapore and traveling somewhere in the region.
It seems from the above simulation that on a per day basis cruise travelers save around $50. Multiply this over a week’s trip and savings start to add up with Cruise trips becoming $350/week/per person more economical than standard holidays. The above is for an average Singapore traveler traveling within the region; however such simulations have been done for western travelers, showing similar results.
The other thing we haven’t considered are large discounts that cruises offer for kids (i.e. special prices for shore excursions, no gratuity for kids under 2, and discounted pricing for children staying in your stateroom). This adds even more to the savings versus a regular trip, and becomes very economical for a family on a budget.
Considering the above economics, we were surprised to learn via RCL’s 10K that cruise penetration around the world is actually quite low.
Now this is a percentage of the total population, and not all travellers. But for example in 2019 nearly 120MM Americans travelled for the holidays, which implies that the penetration rate for travellers is also in the single-digits. This brings up a curious question as to why considering its attractive propositions. One of the reasons could be an over-reliance on traditional travel agents who still control ~70% of ticket sales[1] and most modern travellers no longer use such agents. Perhaps there’s an opportunity that post-virus cruise lines start to ditch agents, go digital, and save significantly on margin (commissions eat up 15% of revenues). This would allow cruise lines to reach a new audience and save on cost but alas, a quick look at the last few earnings calls from RCL seems like they are sticking with the traditional agent distribution model.
Is the Capex worth it?
Now if you’ve never seen a cruise ship up close, it’s quite awe-inspiring. These ships are monsters and standing next to them you really have to crane your neck to see to the top. The Quantum of the Seas, which is the ship we travelled on, for example, is only RCL’s fifth largest and is still nearly 350 meters in length, 16 stories tall, and can carry nearly 5,000 passengers and 1,500 crew. It cost roughly US$1 billion to build.
Without even considering the operating expenses and the maintenance the $1 billion seems to be a hefty price tag. Thus we thought we’d see what the payback period looks like. This is only looking at the build cost versus revenue made (ie cash out versus cash in), so it’s just a rough gauge, but lets look at some numbers.
The above surprisingly shows a very fast pay-back period of just ~2.5 years for just the initial investment versus revenue. Obviously, if you account for commissions, operating expenses, financing costs, maintenance capex etc., breakeven through profitability will probably stretch to a few more years, but it still seems quicker than we thought. Part of this is driven by high occupancy which is regularly over 100% (due to children) and the fact that RCL maintains significant pricing power (from 2017-2019 they increased price per passenger day by 13%).
Overall thoughts
Given our experience on our recent trip and some number crunching above there is certainly something to the cruise line business, with a lot of positive aspects going for it. It seems like cruise-goers agree as more than 50% end up becoming repeat customers[2]. I for one, will be part of that 50% as given my experience, would happily go on another cruise once the world returns to normal.
That said, as stated at the beginning of this blog, this is far from a ringing endorsement of an investment as there a number of other hurdles to overcome. Most importantly the industry’s high liability count. For example, RCL has $35billion worth of liabilities (including all commitments and contingencies) versus assets of $31billion. However despite this fact, this is a business we would keep our eyes on (frankly cruise line stocks are not trading particularly cheaply right now) and if we get comfort over their ability to handle debt and perhaps see a bigger push to digitalization, we might just find ourselves investing with not just our holiday days.
We hope this post inspired you to look into the industry further, or at the very least made you rethink your next holiday. Thanks for reading and happy investing!