BUILDING FOR THE CRUISE INDUSTRY
Where Shipyards and the Cruise Industry Collide
By Mike Vaughn
February 1, 2002
Over the last twenty or so years the cruise industry has undergone amazing growth and prosperity. Carnival Cruise Lines lead the way taking the industry from an expensive vacations to the mainstay of American and European vacations.
By reducing the cost of sailing and improving the availability, Carnival and others brought the industry into a period of unparalleled growth and prosperity. Although over the years various cruise lines have come and gone and many have merged, it has been a period of growth.
For the last five to ten years, I marveled at the ability of the industry to spin off older ships into less profitable markets and introduce new, larger and more expensive ships into the primary cruising areas. Reality is always that saturation will occur at some point. However, no one anticipated an event such as the World Trade Center attack.
The immediate consequence of the attack was for Renaissance Cruises, American Classic Voyages and some other smaller cruise lines to go into bankruptcy and cease operations. Whether their failures were a direct consequence of the terrorist attack or just the last event in a series of problems is difficult to really know. The end result, however, is the same. Fewer passengers means higher costs of doing business.
I once described the cruise industry as a shepherd raising dragons. As long as the dragons are well fed and happy, life is good. When things go bad, the dragons immediately eat the shepherd. The costs of maintaining a cruise ship or a series of ships is an enormous expense that does not rest in bad times. There is only a certain amount of expenses that can be reduced when the demand for the ship falls below a certain level.
The immediate answer to a decline in revenue is to move the vessel into other service or into lay up. The current world status has greatly reduced the possibility of other markets for many cruise ships. The options then are to lay up the ship or send it to the scrappers.
We will probably see a good deal of both courses of action over the next few years.
However times of crisis may be times of opportunity. It is now a buyer's market. This is well noted by the ongoing attempts by RCI and Carnival to purchase or merge with Princess Cruises. These are the three biggest competitors in the market and each is looking to take advantage of a situation that is in a state of flux. They are all obviously dedicated to the proposition that cruising passengers will return in greater numbers than before. This of course waits to be seen. However, some small cruise lines, with whom I have had discussions, have noted a very positive trend in future bookings. Will this hold for the long run? No one will know until December of 2002.
Another aspect of the market that has not been greatly appreciated by the mainstream media is the number of ships on the way from major shipyards all over the world. From Chantiers de l'Atlantique in France to Mitsubishi in Japan, there are more than 47 ships either under construction or under contract to start construction as of July 2001 for delivery by the end of 2004.
The fall out of the WTC attack was immediately felt in the Ingalls Shipbuilding yards when American Classic Voyages ceased operations and the two ships under construction went idle. This contract represented $880,000,000 to the shipyard. It will probably also represent close to that amount in legal fees trying to sort out the blame and what to do with the unfinished vessels.
Based on data immediately prior to the WTC attack, the industry was anticipating the following:
- 43 ships were under construction or contract to begin construction (including Ingalls contracts)
- Total contract costs were $14.718 billion dollars (all figures in U.S. dollars)
- Total tonnage was 3,318,206
- Total passenger berths 79,348
- Total shipyards involved 10
- Total countries involved 7
- Delivery in 2002 16 ships
- Delivery in 2003 17 ships
- Delivery in 2004 10 ships
The largest ship by tonnage & LOA was the 150,000 ton Queen Mary by Cunard, 1131.8 feet.
The three major Lines had large commitiments to growth for the period between 2001 and 2004.
RCI has seven ships under construction with a total of 763,900 tons at a cost of approximately $3.2 billion dollars.
Carnival has six ships under construction with a total of 595,700 tons at a cost of $2.475 billion dollars.
Princess Cruises has 510,806 tons under construction at a cost of $2.065 billion dollars.
RCI will add 16,246 berths to its fleet, Carnival 18,040 berths, Princess 11,700 berths. This represents 58% of the berths coming with all of the new construction.
From a practical booking standpoint allowing a 44-week cruise market for each ship, this means that there will be 3,491,312 weeks of space available when all ships are delivered. This space will be in addition to existing berthage on current vessels.
If previous trends return to the market, this space will quickly be used. However, if the market does not return, there is a possibility that a glut of space will affect the viability of the companies. As I said earlier, this is the dragon that you must watch.
There are alternatives for the cruise line to consider during this period. First, this is an excellent time to dispose of older, less productive equipment. This is done by selling ships into scrap or into less productive markets. The economic danger of selling older ships is that they may have less debt associated with them than new ships and may be in a better position of posting profits where newer, more expensive ships may not.
An alternative theory is that older ships continue to decline in value with each year and that they cannot attract newer more affluent passengers. The trend has been to provide bigger, greater and grander cruising experiences. The market will determine whether price or experience determines the choice of the customer.
A strategic decision for the cruise line management is whether to use this time as an occasion to relieve itself of older, worn equipment in favor of modern, cheaper-to-operate equipment and position itself for the market that will return in a few years. There is a danger of allowing the fleet to become too aged to be competitive. The fine balance between costs and income must be retained. If the company commits itself to all new and modern fleet and the market does not return quickly enough, the profit/debt ratio may destroy the value of the company.
A larger unreported issue is where the shipyards stand in this economic situation. As may be seen by the American Classic Voyages abandonment of the Ingalls Shipyard project, the shipyard is now facing a loss of several thousand jobs. U.S. Government guarantees may soften some of the blow, but eventually the economic impact will be substantial in the economic community of the shipyard, from welders to food suppliers.
In the wider international view, it is important to consider that shipyards in France are committed to 13 building projects, primarily at Chantiers de l'Atlantique. Celebrity, Crystal Cruises, Cunard, Mediterranean Shipping, Princess and RCI all have projects going there. Italy also has 13 projects under construction for Carnival, Costa Cruises, Holland America, Princess and Radisson Seven Seas Cruises.
The economic impact on these countries could be tremendous if the projects are reduced, retarded in delivery or canceled. The cruise line may have a number of options in dealing with the shipyard. These options have a range of impact:
- Retard delivery. This permits the yard to continue to work on the project but postpones the delivery date. The value of this is obvious in a slow market. However, financing costs and penalties may apply. It is an option that is not without expense.
- Cancellation. In a situation like this, the cruise line merely cancels the entire project, pays the penalties and expenses and walks away from the project. This is very expensive last resort.
- Sell the position. The cruise line may sell the project to another cruise line for some amount of money that represents its current investment with a discount. This assumes that there is someone who wishes to buy. This is not an unusual event in time of economic change.
- Government Assistance. Depending upon who financed the project and where it is being built, the government may step in to assure that the project is completed rather than allowing the economy to be disrupted by the cancellation.
The shipyards, depending upon their own financial solvency, are faced with a variety of options. Generally, if the yard is sound or has good government support, it will work with the shipping companies to assure completion of the project. It is not unusual for shipyards, just like shipping companies, to face such a downturn in the market with immediate filings of bankruptcy.
The industry, local economy, and government all need the industry to continue. During times of economic stress, slow thoughtful decisions are better than quick, short-term decisions. However, the dragon is restless and the events of the next 12 months will probably set the tone for the industry for the next 10 years.
My recommendations are as follows:
- Times of crisis are times of opportunity.
- Evaluate a cruise line ship by ship.
- The debt/income ratio is not applicable to times of crisis. Use a debt vs. capital value ratio.
- If a company is cash rich, it may be an excellent opportunity to acquire and expand.
- If a company is short on cash, dispose of older ships in favor of modern, more economical ships.
- Market location and cruising zone may be as important as all other factors. The less developed markets of Asia and the Far East, may become the next Caribbean. The primary question may be, "Where do passengers feel safe?"
- Bigger may not always be better. Smaller ships in smaller markets, may be the wave of the future.
The next few months will be interesting times for the industry.