10. The Future of Cruising Boom or Bust?

A Worldwide Analysis to 2015

http://www.shipsandcruises.com/Future_of_Cruising.htm

Author: Tony Peisley; Publisher: Seatrade; 300+ pages softback; Price: US$945 including p&Pm, UK525, Euro price on application. Available at www.seatrade-global.com (secure payment site). Recently Tony Peisley, a UK-based journalist and cruise industry analyst and Director of A. R. Peisley Ltd (Cruise Analysts) issued a research report on the future of cruising. Peisley has been writing about passenger shipping since 1974 and this is the sixth in a series of major research reports he has produced on the cruise industry since 1992. A summation of the The Future of Cruising follows below. ****** The clearest evidence yet that there is to be no turning back from the worldwide cruise industrys expansionist route map came the day this research report went to press February 6, 2006 when Royal Caribbean Cruises (RCC) ordered what will be the worlds largest and most expensive passenger ship. Designated for its Royal Caribbean International (RCI) brand in 2009, this Project Genesis ship will cost 900m (US 1,685,652,071.24) and, at 220,000-ton, dwarf even the RCCs 158,000ton Freedom of the Seas which [now carries] the worlds largest tag (also built by Aker Yards in Finland). The Genesis ships (an option for a second is included in the order) will carry 5,400 passengers and represent another major step in both the cruise product and also in the business model that drives it. There can be no argument that the cruise industry is booming. It has experienced consistent growth in all its major source markets over the past ten years and the two leading cruise companies, which account for about 70% of worldwide cruise capacity, are reporting substantial - and everincreasing - profits. But, with worldwide capacity set to increase 75% by 2015, the question of whether the recent levels of market and profit growth is sustainable is one that is increasingly being posed by financial and corporate analysts. Although there will always be the possibility of unforeseen events or developments outside the control of the major players within the industry, the answer to that question to be drawn from the report that follows is clearly a positive one. All the key indicators are that, for the foreseeable future, the cruise industry will continue to grow its sales, revenue and profitability. As a still maturing industry, there may be year-on-year

variations, but the underlying supply-demand cycle appears set to continue ensuring growth in all key markets. Crucially, too, the business model of much of the industry is changing to take into account both the economies of scale and also the flexible pricing opportunities inherent in the ever-larger ships being built. This is creating a classic virtuous circle where lead-in prices can be reduced to stimulate the market without damaging overall yields. While the average capacity of ships delivered in the 1990s was 1,627, this is likely to increase by more than 1,000 berths for those delivered between 2000 and 2010. The average has already increased from 1,773 for deliveries in 2000 to 2,907 in 2005 and this trend is certain to continue from 2006 through 2010 becauseeven before the latest RCC Gemini order18 of the 30 ships on order/option were to carry more than 3,000 passengers (five of them more than 4,000). This reflects an ordering pattern which shows virtually all the new ships coming either from mass-market Contemporary brands or from the Premium brands which are increasingly building ships of similar sizeif slightly lower density. In fact, about 70% of all capacity added between 2006 and 2010 will come from Contemporary brands, with Premium brands accounting for the remaining 30%. Only two Luxury ships, with maximum 500-700 berths apiece, are likely to be delivered during the same period. Profitability The 2005 results of the top three cruise companies (Carnival Corporation, Royal Caribbean Cruises/RCC and Star Cruises Group) suggest that the worldwide industry generated revenues of more than $22bn and profits of more than $3bn. The top two enjoyed record years for both revenue and net income (profit). Carnival saw its revenue increase 14% to top $11bn for the first time with profits up 22% to $2.2bn while RCC increased revenue 8% from nearly $4.6bn to just short of $4.9bn and profit by 51% to $716m. Still in the throes of major brand and operating policy changes, Star Cruises Group remains a long way behind Carnival and RCC not just in capacity but also in profitability. For the first nine months of 2005, though, profits rose more than 50% to $44m on revenues that increased 12% to $1.4bn. Significantly, the (privately-owned) company emerging as a major player in the industryMSC Cruisesreported its first break-even year in 2005 as it stepped up its building program to renew a loss-making fleet based on old, second-hand Budget ships with a series of new Contemporary vessels. Supply And Demand At the beginning of 2006, there were 30 ships on order or optioned for a combined cost of nearly $16bn. This means that, if there are no more orders,

96 cruise ships will have been delivered between 2000 and 2010. In fact, current ordering patterns suggest that up to another ten will be added for delivery before the end of 2010. With allowance being made for ships being scrapped or otherwise permanently removed from service at a higher rate than normal due to new SOLAS regulations being introduced at the end of 2009, this means that available cruise berths will grow from 350,000 in 2006 to 588,000 in 2015. At the same time, passenger numbers should increase from the forecast 15.1m in 2006 to 25m by 2015. This will mean the 20m mark being reached and passed in 2011just a year later than had been forecast prior to 9/11 and its dampening impact on global tourism (especially ex-North America). Source Markets Final figures for 2005 were not available for all markets as this was written but indications suggested that growth in both the major markets of North America and the UK had been higher than expected in both for respective year-end totals of more than 9.9m (up 9%) and nearly 1.1m (up 5%). Similar steady growth was experienced in the rest of Europe so, with the Asian market still in slight decline, a worldwide increase of about 7% to 14.4m cruises booked is estimated. Carnival is, though, predicting rapid growth in the UK market which it believes could reach between 1.7m and 2m by 2010 while the rest of Europe could be contributing anywhere between 2.5m and 3m (i.e. up to 70% higher than the 2005 total) by then, depending on how much capacity is dedicated to the region. Dominance Of Major Players Although there remains a healthy amount of activity around the fringes, with smaller brands continuing to emerge or expand, it is clear that the main industry growth continues to be driven almost exclusively by the major players. This means an inevitable increase in the market shares of the top three. In 2002, Carnival, P&O Princess (P&OP), RCC and Star Cruises Group accounted for 69% of capacity; in 2006with P&OP now part of Carnivalthe top three have 79.5%. On current orders/options, that share would increase to 81% by 2010 but, with eight or nine of the ten orders still expected for 2008-2010 delivery almost certain to come from these three, that share could be as high as 87%. With the emergence of MSC Cruises as a fourth major player which is likely to be placing regular orders from 2010, though, that top three share is not likely to grow significantly higher by 2015.

Cruise Shipbuilders A similar pattern of major player dominance and consolidation is emerging amongst the specialist cruise shipbuilders. Just four account for 29 of the 30 current orders/options andas with Carnival/P&OPthat four could become three during 2006 with Norwegian-owned Aker Finnyards set effectively to take over France's Chantiers de l'Atlantique. This would create a strong second force behind Italy's Fincantieri which, through a "special relationship" with Carnival Corporation, has built up a dominant 50% share of the market. Although new cruise ship prices continue to rise (by 10%-40% depending on the size/type), the increasing size and complexity of the ships and their specifications have combined to ensure that margins remain small for shipbuilders and prompted them all to look for ways to either reduce or spread their costs. Ship orders have begun to accelerate after a post-9/11 lull but their numbers are unlikely to reach the 12-14 a year peak of 1999-2004. Apart from any other factor, the increasing size of the ships means that cruise companies do not need to build as many to add the same amount of capacity. Although the value of each order has grown in line with their increasing sizes so that the overall revenue accruing to shipbuilders has held fairly firm, there are inevitably less orders around and so those shipbuilders are targeting alternative revenue streams. These include the fast-growing market in major refurbishments (including ship-stretching) as brands seek to update 1990s-built ships to improve both their passenger appeal and also - through retrofitting balconies to cabins and adding new cabins and suites - their profitability. Accordingly, Fincantieri is negotiating to buy stakes in refurbishment specialists in the Caribbean (Grand Bahama) and Northern Europe (Lloyd Werft) while Aker Finnyards has set up a specialist department to market its own refurbishment expertise. Fincantieri has also linked with specialist companies in the Superyacht sector (see later in this summary). Economic Impact The latest of what are now annual studies conducted for the International Council of Cruise Lines (ICCL) reported that the cruise industry generated more than $30bn for the US economy in 2004a 50% increase on 2001. It also supported a third more jobs at 135,000. A separate study showed that cruising had benefited Canada's economy by C$1.8bn in 2003 and, as the concept of Homeland Cruising spreads across North America, many more of these studies are now being carried out by ports, local and regional authorities to support (or justify retrospectively)

public investment in new or enhanced cruise port and tourism infrastructure. One of the major benefits of these studies is that they can be used as leverage by the industry when lobbying for improvements in their operating environment and this has now been recognized in Europe where the European Cruise Council (ECC) has joined MedCruise (Association of Mediterranean Cruise Ports) and (probably) Cruise Europe to sponsor their own major study during 2006. Destinations And Port Developments The Caribbean remains the most popular cruise region with nearly 50% of the capacity marketed in North America during 2005 but the major change within that figure is the increasing share of Mexican ports and those of other Central American countries. This is due to the emergence of so many new cruise homeports along the USA's Gulf Coast from which Central American ports are the most convenient destinations. Although what the cruise industry described as the "worst-ever" hurricane season damaged several ports and put New Orleans out of action for a year from late 2005, this is unlikely to do more than temporarily stall the growth in the region's cruise tourism. One of the ports worst affected, Mexico's Cozumel, remains firmly established as the world's most popular cruise port of call with nearly 3m annual visitors. Mexico is also the most popular cruise country destination with nearly 8m cruise visitors (counted across all its ports). Elsewhere, Northern Europe has seen its share slip slightly since it peaked in 2002 with nearly 11% and took second place to the Caribbean in Cruise Lines International Associations (CLIA) top destinations. The Mediterranean has since regained second place with Northern Europe falling to fifth but all European destinations are seeing renewed growth as European brands Costa and MSC Cruises and US-oriented brands RCI, Celebrity, Norwegian Cruise Line and Princess deploy more ships while Carnival Cruise Lines builds on the success of its first season (summer 2005) in the Mediterranean. Many of those brands are also becoming increasingly involved in cruise port and/or terminal ownership, development and management. The latest move was made late in 2005 by RCC, as part of a consortium tendering for a multi-million dollar development of a cruise port in Istanbul. It already has a stake in another Turkish port, Kusadasi, and it follows other cruise line involvement in terminals at Savona, Naples and Civitavecchia (Italy), Barcelona (Spain), Costa Maya (Mexico), Grand Turk (Turks & Caicos), and Casa da Campo (Dominican Republic), San Diego (USA) and Alaskas new port of Icy Strait.

Star Cruises is also tendering to develop a new cruise terminal complex at Hong Kong and is competing with Carnivalamong other tenderersto develop a casino resort at Singapore which could include a cruise terminal and up to eight cruise berths. It is also leading the way in attempting to open up China both as a cruise destination and major source market. River Cruising Passenger numbers and, more recently, yields are both growing significantly for river cruising in its major source market, Germany. In fact, river cruising sales continue to grow faster there than for ocean cruising. Capacity is also increasing on European rivers as established and emerging operators renew or expand their fleets with larger, more sophisticated vessels. More than 500,000 passengers (80% European; 20% North American) now cruise annually on European rivers while on the Yangtse, the international cruise passenger total is approaching 150,000 as operators to China are also beginning to add new and larger vessels to appeal to their prime source markets in North America and Europe. Superyachts While growth remains stalled among Luxury brands, which were affected more than any other sector of cruising by 9/11 and the Iraq War, there has been an increasing focus on the emerging Superyacht sector to see if there are any profitable synergies with the conventional cruise industry. To date, the main overlap has been among the specialist shipbuilders (e.g. Fincantieri linking with Superyacht builder Benetti) and ship management companies (e.g. V Ships linking with Fraser Yachts) but there are also hopes that the increasing popularity of shared, fractional ownership could create a new luxury cruise charter market. What is not in doubt is that there is a major building boom underway with between 400 and 500 Superyachts on order in 2005/06, for a combined cost of approaching $2bn. The average size of the yachts is also increasing all the time along with the range of on-board facilities and to a lesser extent their capacity. Issues The cruise industry continues to be challenged by politicians, environmental and other lobby groups. Inevitably, this pressure is greatest in North America and not just because this is where the major companies are based and the majority of passengers are sourced. The fact remains that the industry's foreign-flag status is still treated with suspicion by those who believe that it is a device for companies to avoid taxes and regulation.

There are, though, signs that through ICCL the industry is improving its image presentation and its effectiveness at lobbying for its own interests. The substantial investment being made by the major companies in wastedisposal and other environmental systems on board their new ships is also beginning to pay off as the sector appears to be winning more supporters for its claims that it is meeting and often exceeding legal requirements in this area and, in doing so, outperforming many land-based tourism sectors. Also, in its key Caribbean destination, it hasthrough the FloridaCaribbean Cruise Association (FCCA)forged much closer links with government and groups such as the previously hostile Caribbean Hotels Association (CHA). But there are still problems ahead with issues such as the application of the Americans With Disabilities Act, which has yet to be clarified to the industry's satisfaction, and the growing involvement of the US Homeland Security department in tourism-related activities. The latest of thesethe Western Hemisphere Travel Initiativewill effectively withdraw the previous passport exemption for US residents traveling anywhere in the Western Hemisphere. This raises significant concerns not just for the cruise companies but for all those involved in the Caribbean's tourism industry. Publishers Note: Some of the data for 2005especially that from source marketswas not yet available as this report was written but this (along with the impact of the RCC Genesis ship order) will be incorporated in an update to be sent (by email attachment) to buyers of this report during summer 2006.