Cruise Lines Continue to Maintain Moats

Jaime Katz: We recently reassessed the economic moat sources of the cruise industry within Morningstar's moat frameworks and found our narrow moat ratings still hold for Carnival, Royal Caribbean, and Norwegian.

First, we assessed the efficient scale moat source, which we believe represents the strongest moat source for the cruise companies. Out of the eight factors that could support an efficient scale moat, the cruise companies display five factors, including high sunk costs, significant entry barriers, historical precedent, excess capacity, and mature demand.

Then we looked at the brand-intangible asset, noting that yields have grown faster than inflation over the past five years. We believe this is attributable to better revenue-management systems, more dynamic pricing, and better marketing, supporting the positive perception of each brand.

Finally, we revisited the cruise companies' cost advantage, highlighting industry-specific metrics including proximity, buying power, and low-cost finance which have significant relevance for the cruise operators. Benching Carnival, Royal, and Norwegian against smaller companies in the space offered quantitative proof that costs across the larger fleets were more competitive.

While all three companies are undervalued, we still believe Norwegian trades at the most compelling discount to our $67 fair value. Given the still relatively smaller size of Norwegian's fleet, we expect 5% capacity growth on average over the next five years, supporting high-single-digit earnings per share growth with the capture of just 2.6% price hikes. Over the near term, we believe Norwegian's lower penetration to European consumers provides relative safety in pricing, in comparison with Carnival and Royal, which source a greater percentage of customers abroad, protecting the region's yields.