"The pessimist complains about the wind, the optimist expects it to change, the realist adjusts the sails." -- William Arthur Ward
Some months ago, I was invited by management at Sir Richard Branson's nascent Virgin Cruise Lines, Ltd. to bid on a consulting contract to help plan the conceptual design, configuration, marketing and operations of the casinos aboard his new cruise ships. Now under construction at an Italian shipyard, the three vessels are all expected to offer casino gaming.
My consulting business runs on a Peter Drucker model -- i.e., usually a one on one relationship working of challenges and issues with members of senior management. In this instance, Virgin ultimately elected to hire a large consulting group working with mid-level management because there was no in house gaming experience to develop preliminary plans.
During the course of my own research for the presentation I looked at the cruise business globally, and became intrigued with Carnival Cruise Lines (NYSE:CCL). I studied their business and numbers and came to believe it was undervalued. To support my take on the shares I went to my existing files on gaming at sea and the cruise business in general and asked the investment manager of my gaming blind trust to have a look at prospects for herself. At this point I am unaware of whether she acted or not on my thoughts about Carnival, maintaining my policy of avoiding any possible conflict of interest if at some point further down the line, I'm called back to consult by Virgin.
Several intriguing factors jumped out at me in the course of my research. Carnival was a widely recognized solid performer, which even at its current trading range, looked cheap to me. Two simultaneous developments in the global cruise business supported my conclusion: One, Genting, the global gaming giant which owns the Asia-based Star Cruise Lines, was gearing up marketing to attract the Macau customer base to their expanding cruise business. My sources inform me that the move is in part a response to events in Macau gaming-but not the central driver. "Genting sees what's coming. China is ground zero for cruise business growth over the next five years," said a marketing executive and former colleague now working in that sector. And two: Apparently Carnival reads from the same page as Genting.
Both in its public statements as well as my own Miami-based sources in the cruise industry, Carnival has clearly put Asia in its periscope.
Here's why: Of its current fleet of 99 ships, Carnival will add a fourth Asian-based ship this year, two of which will offer year round cruises. More critically beyond this year, Carnival's Princess Cruises brand will join the Carnival and AIDA brands and introduce the Majestic Princess, its first ever ship specifically designed for Chinese guests. They've also entered joint venture deals with China Shipbuilding Corporation and China Investment Corporation to co-finance its big Asia expansion.
"You'll see the Carnival moving ships at a speedier pace into the Asia markets than before this year," added our source. "They're already shifting capacity from North American and Europe to Asia."
Currently, China represents only 5% of Carnival's global revenue base of nearly $16 billion. "There's immense room to grow the business in China and Carnival has the balance sheet to support its long term goals both in capacity and marketing," our source added.
The Carnival China Rationale
As of this year, outbound travelers from China numbered 135 million. Their expectation is that this number will grow to 200 million by 2020. "On board passenger gaming on these ships will average significantly higher than it does on ships cruising other parts of the globe," said our source. "Though its only one component of on board revenue it will step up front as a major contributor there."
Like Macau operators Carnival sees the tourism future in Asia as the brightest spot on the globe. Travel restrictions are being eased by the government and the Chinese upper middle class, as we have noted in many of our Macau casino articles, is growing rapidly. "The population pool is the world's deepest and the spurt in the percentage of the working population emigrating into middle or upper middle class status, is staggering to contemplate," said an investment advisor we know whose entire clientele is drawn from Chinese families.
Cruise ships in general and Carnival in particular, are basically floating integrated resorts, totally analogous to land-based casino hotels offering the same diversity of amenities in dining, entertainment, amusements and shopping. "There's one difference, gaming regulations covering cruise ships offer greater flexibility to operators on many fronts."
Carnival has eight new ships under construction for delivery between 2018 and 2020, bringing its total fleet to 107. It can move its ships like so many chessmen in a global game and most of the action will take place in Asia both in the earmarking of new vessels as well as the redeployment of existing ones.
China upside notwithstanding, Carnival looks cheap to us now.
A few numbers to contemplate:
- Carnival price at writing: $46.72
- 52 week range: $40.52-$55.77
- Average volume: 4,631,833
- Market cap: $34.83b.
- P/E: (ttm): 16.10
- EBITDA: $4.15B
- Dividend and yield: $1.40 (3.1%)
The dividend isn't as good a Las Vegas Sands' (NYSE:LVS) 6%, but still respectable and sustainable in what is rapidly becoming a market that fewer and fewer investors understand. Both companies are essentially in the same business, integrated resorts -- except that clearly for LVS, the gaming component is central, while for Carnival, it's a nice amenity. However, that's going to change dramatically as Carnival's Asian business takes hold and the gaming amenity blossoms. The irony here: LVS is becoming more like Carnival and Carnival will become more like LVS in terms of gaming and non-gaming revenue streams. You want to be a holder of both in our view since they also share strong managements, cost focus and ever diversified amenities.
Carnival's overall capacity growth is projected at 3.5% this year from a 2015 base of 10,800,000 passengers. Last year it booked over $170 million in cost savings and believes there's more to come. Yet while the S&P has moved 3.43% to the upside over the year, Carnival is down 10.95%. People aren't paying attention; all we're saying is that facts are facts.
More items to contemplate:
There's the Brexit decline; the stock is down 7% since the vote. This undervalues Carnival's UK-based Cunard and P&O cruises, which we see actually benefiting from the move. They both sell cruises in British Pounds, which as we know took a big hit after the vote. There was no Brexit bounce for the shares we're guessing because of general global jitters. But to us that's another signal that any currency advantage Carnival will get from Brexit presents another rationale for an entry point to the stock.
Carnival has benefited significantly from lower fuel costs since that market slide. Here's what it spent on fuel:
- 2013: $2.2b
- 2014: $2.03b
- 2015: $1.29b
Due to the volatility of global fuel markets, Carnival has an ongoing program of hedging fuel futures to ensure as stable an operating margin number as possible. The decline has clearly had a favorable impact on 2015 earnings. To get a wider view on prospects here we looked at a consensus of opinion as to where fuel might be headed. Goldman Sachs has recently put the number at between $45 and $55 a barrel. Other sources we checked saw a more pronounced slack in demand even against lower production envisioned for 2016/2017 due to the ability of producers in limbo to quickly ramp up production. Fuel prices according to company numbers have a 10c per share impact on the trade.
If Carnival can maintain their fuel cost at either the 2015 level or somewhat lower, we see that, coupled with an upside in bookings, the Brexit bonus and, of course, the trending China move, we think the one-year consensus target of $57 edges on the low side for this very solid performing company. With a debt to equity (mrq) of 41.15 we see the company extremely well positioned to ramp up revenues in the intermediate and long term by adding capacity. But faster and more probable is the potential of reconfiguring or simply redeploying its existing fleet to accommodate the expected surge in Asian tourism.
Dominating 47% of the global cruise market with a high percentage of stable, repeat customers, Carnival represents at the moment an undervalued, solid stock worth a close look by investors who want stability, upside appreciation potential, and respectable yield.
Our target: $65 by the end of Q2 2017.
About the author: Howard Jay Klein is a 25+year C-level executive of the casino industry and presently a consultant in that space. He is the author of Mastering the Art of Casino Management and publisher of The House Edge site on Seeking Alpha. His own gaming portfolio is in a blind trust for his family so as to avoid potential conflicts of interest with past, present or future clients.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.