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Morningstar | Slowing Yield Improvement Offset by Solid Cost Control, Preserving Profitability at Carnival

Carnival is the largest company in the cruise industry, operating 10 global brands with more than 100 ships in service and passenger capacity of more than 200,000, allowing it to reach a diverse group of consumers in a lightly penetrated vacation segment. Efficient scale, the lowest unit costs in the industry, and intangible brand assets provide the company with a narrow economic moat.Carnival's market is underpenetrated, with less than 4% of the domestic market ever having cruised. With low domestic penetration rates and even lower international recognition (less than 3% in Europe), upside potential remains significant. The repositioning and deployment of ships to faster-growing and underrepresented regions like Asia-Pacific should help balance supply in high-capacity regions like the Caribbean, which should provide for more strategic pricing tactics globally. In our opinion, Carnival has the best ability to capitalize on these underserved international markets, thanks to its global reach and tailored fleet.Domestically, the aging population remains key regarding the supply/demand imbalance in the cruise industry, in our view. This segment will drive demand and create a disconnect between the demand in the market and the supply of berths for at least the next 10 years as the 65-and-older demographic grows faster than overall cruise industry capacity. Carnival continues to source about half of its customers from the region, where the stable employment situation should support lower-income consumers' willingness to spend, helping the namesake Carnival brand continue to deliver double-digit adjusted returns on invested capital (with the firm surpassing our weighted average cost of capital estimate in 2018).The firm is set to receive 15 ships between 2019 and 2022, boosting supply growth over the next five years. In our opinion, it can still lower costs through improved procurement expenses and better fuel efficiency; ships using liquefied natural gas came into service in 2018. It can also improve revenue via the revenue management optimizer it implemented across six brands, which should help improve EBITDA margins to 31% from below 30% over the next five years.