City Insider - FT journalist David Stevenson on the travel industry

Travelport logo
In association with Travelport

Carnival’s impressive second quarter results from last week should remind us why investors continue to rate the cruise industry the most attractive bit of the travel sector.

Despite its well publicised problems with Costa (which is itself boasting a new boss in Michael Thamm – yet more Germans venturing into the heartland of Mediterranean indebtedness), Carnival turned in numbers that genuinely surprised analysts in New York and London – in a positive way.

Revenues were up, profits increased and chief executive Micky Arison even managed to raise full year expectations and beat guidance issued last quarter.

Here’s Arison rightly trumpeting Carnival’s greatest achievement in what has to be a difficult market: “Cruise ticket prices (excluding Costa) held firm close to sailing which, combined with stronger than expected onboard revenues, drove yields above prior year levels. Our North American brands performed well, achieving a 3% revenue yield improvement compared to the prior year…”

Look in detail though at these, and other, numbers coming out of Carnival in the last year and one begins to realise the power of this leviathan, attractions that aren’t going unnoticed in the mainstream investing community.

In fact more and more boring, conservative value-orientated investors on both sides of the Atlantic are falling under the spell of the sector leader, for four very simple reasons.

The first is that Carnival has easy access to the global capital markets, at low rates (probable net of tax costs are around 5% per annum) which allows it to continue to expand capacity – although that growth in capacity is now slowing down a tad.

Debt levels at Carnival are much lower, in relative terms, than its two nearest competitors yet it can continue to plough vast amounts of hard cash into capacity expansion – and push its competitors to go even deeper into debt to keep up.

That continued capital expansion by Carnival wouldn’t amount to a can of beans if Carnival wasn’t also able to extract a superior return on capital employed.

Unlike so many other leaders in the travel industry, Carnival continues to produce net returns on assets employed which are close to top of the class. That capital efficiency is helped along by onboard capacity which remains consistently above 100%.

The killer advantage though is that Carnival seems to be deploying its huge scale in one crucial area, input buying – it’s continuously managing to squeeze down onboard ship costs, excluding fuel.

In simple terms, it’s now so huge in market share that it can afford to nail its suppliers’ margins to the floor.

Last but by no means least, it’s obvious from these quarterly numbers that outside of some European markets, its market segment – mass market cruising – is continuing to grow with impressive numbers coming out of both the US and Asia. This is still a growth market, unlike virtually every other area of travel.

Influential US blog Gannon on Investing has taken these strengths and run the numbers in great detail – it’s absolutely worth reading the resulting report.

The key unknown factor, of course, is the level of global oil prices – more on that next. As Carnival doesn’t hedge its fuel inputs, its share price has in effect become a geared play on the price of crude oil, which is – rather conveniently – heading down sharply in price at the moment.

Based on these numbers and the superb analysis by respected financial blogger Geoff Gannon, I’d hazard the following observations

1.      Despite a whole range of competitors throwing money at new cruise businesses they’ll nearly all fail, especially at the mass market level. Carnival will use its scale to grind down its competitors over the next five years.

2.      Its two main competitors will survive and prosper at the luxury end of the market. Royal Caribbean’s slightly less intensive use of onboard passenger space for instance will probably allow it to offer a premium service, but in a new world of lower-than-trend growth, I’d worry that premium cruising will struggle to push up its share of the market.

3.      Last but by no means least I’d expect the big cruise giants to continue to target promotional low price offers designed to attract yet more mass market customers away from a conventional family holiday in Majorca. The push into families and younger people will intensify in the next few years and Carnival will ignore its lack of pricing power (common to all its peers) to push prices down to eliminate any new competition.

What to expect in the next few months

This month’s column is coming hot on the heels of the European summit. If we’re to believe the optimists, this star-studded event is supposed to be a make or break affair in which the Eurozone is finally stabilised amid a clamour of fiscal and monetary rectitude and integration.

Except of course nothing of the sort will happen and we’ll just limp into a long, cold summer with more panics and subsequent ‘all hands to the pump’ central banking brinkmanship.

Most institutional investors are utterly bored of all this uncertainty and have started going to longer lunches to avoid making any big bets, leaving most business leaders wondering what on earth might happen next. 

Luckily those hard working hedge fund types are still tethered to their plush desks in Mayfair, making over-sized bets on what might happen in the second half of the year.

Fortunately for the laymen and women of this world, investment banking economists and strategists closely follow these trades and here’s a quick round up of what are probably the main ‘consensus’ trades.

·         Sterling will continue to increase in value relative to the Euro with options pricing suggesting a new target of 1.30 by the end of the summer.

·         There’s more unusual quantitative easing on its way – and Operation Twisting in the US, with the Fed buying huge amounts of mortgage debt and even more unconventional ‘assets’. But all this monetary priming is having a diminishing effect as the markets look to politicians to do something that might actually make a real difference.

·         The dollar will also strengthen.

·         Chinese growth will slow down but probably not collapse below 6%.

·         Options that track futures markets for mainstream equities are pricing in a sharp fall in share prices and an increase in volatility – expect stockmarket wobbles through to November.

·         Inflation will slow down sharply as some economies slip into deflation.

·         German export demand and consumer spending will slow down sharply from September.

·         Last but by no means least oil prices are currently slipping with futures pricing implying even further falls in the next few weeks. Crude Brent contracts for November 2012 look for prices at $90 with equivalent crude oil contracts at around $70.

The good news in these consensus trades is that consumer inflation is falling sharply and expected to carry on decreasing whilst wage inflation looks like its holding steady.

That twin process (falling oil prices and steady wages) is already helping to improve US household finances markedly but the UK consumer market probably won’t improve very much because of impending government spending cutbacks.