Carnival advances strategy for its future in China

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Buhdy Bok, left, president of Costa Group Asia, and Carnival Corp. CEO Arnold Donald at the China Cruise and Yacht Industry Association conference, after Donald announced an agreement to build ships in China.
Buhdy Bok, left, president of Costa Group Asia, and Carnival Corp. CEO Arnold Donald at the China Cruise and Yacht Industry Association conference, after Donald announced an agreement to build ships in China. Photo Credit: Arnie Weissmann

Carnival Corp. has unveiled some of the strategy behind a brand it is creating in China, saying it will likely sell some of its existing ships to the venture in the next six years.

Moving ships into the brand will get it started in business while a pair of Vista-class vessels are built by a Chinese shipyard.

The first of the newbuilds is scheduled for delivery in 2022. Carnival did not say precisely when it plans to launch the brand, which will be managed as a joint venture with the China State Shipbuilding Corp. and the China Investment Corp., both arms of the Chinese government.

The two Vista-class ships will be built by a separate joint venture between Fincantieri and China State Shipbuilding, and would be the first sophisticated cruise ships built in China.

“Being able to offer cruises on China-built cruise ships represents a new opportunity for us to generate excitement and demand for cruising among a broader segment of the Chinese vacation market,” Carnival global COO Alan Buckelew said.

The joint venture, as yet unnamed, will own and operate the ships. Carnival will have a minority ownership stake, limiting its financial exposure to the emerging Chinese market.

At the same time, Carnival is also building ships for the Chinese market for the brands that it fully owns. Princess Cruises will start sailing the new, 3,560-passenger Majestic Princess from Shanghai next year.

The developments come even as yields have declined on cruises sold to Chinese travelers on brands such as Costa Cruises and Princess, which are already operating in China.

On a recent conference call to discuss third-quarter earnings, Wall Street analysts peppered Carnival Corp. CEO Arnold Donald with questions about China.

Still, despite weaker yields in China and Australia, the company’s net income rose 17.1% from last year.

“Right now, our charter activity is strong in China,” Donald told the analysts. “Our occupancies this year were very good. We anticipated that we would see yields decline, but China is profitable. Occupancy levels are high, which means the increased capacity was absorbed in terms of having guests on the ships.”

Carnival stressed that it is in China for the long term and that currently the China market represents just 5% of the company’s capacity, which means results there don’t yet have great impact either way on Carnival Corp.’s bottom line.

Donald said Carnival is now in negotiations for next year with the wholesalers that provide cruise distribution in China.

“We don’t see any consternation around occupancy for next year,” Donald said.

Cruise analysts were not so sanguine. They noted that negotiations over cruise fares for next year also included, in some cases, retroactive adjustments to charter prices for this year. Carnival also recently pulled its AidaBella ship, sailing for Aida Cruises, from its scheduled deployment in China next spring, sending it to the Mediterranean instead. And earlier it delayed a scheduled 2017 debut in China for Carnival Cruise Line.

Susquehanna Financial Group analyst Rachael Rothman said the concessions on already-signed charter contracts amounted, in effect, to “subsidies” for the Chinese distributors.

“There are concerns that these are signals of near-term overcapacity in China,” Rothman wrote in a Sept. 26 report. “The lack of a positive tone on China was concerning.”

China could provide a solution, however, for a vexing problem facing Carnival and other lines: what to do with older ships that are no longer competitive in the main markets such as North America or Europe.

In comments to analysts, Donald said that berths eligible for removal from Carnival’s fleets will double by 2020 and double again by 2024. He said Carnival plans to sell ships into secondary markets that don’t compete directly with its brands.

But several of the secondary markets, such as Spain and South America, have been in economic decline, while others, such as Australia, have become saturated with ships.

In announcing its plans for the China domestic brand, Carnival said that it would be launched initially “using ships that are purchased from Carnival Corp.’s existing fleet and homeported in China.”

Carnival didn’t say which brands they might come from or how old the ships might be.

In response to a query, Carnival said that ships eligible for removal are judged on “relevance to the guest and the ability to generate a double-digit return on invested capital.”

Most cruise lines depreciate ships over 30 years. Carnival’s oldest ships, such as the Ecstasy, built in 1991, Holland America Line’s Maasdam, built in 1993, and Princess Cruises’ Sun Princess, built in 1995, will be more than 25 years old in 2020.

Donald said their fate depends on customer demand.

“If there’s scarce supply relative to demand, some of the less-efficient ships will continue to sail,” he said. “If there’s not that relative scarcity, then some of those ships will exit. They’ll either go into secondary markets or they’ll leave the fleet and be scrapped.”

Carnival has sold 18 ships since 2006, CFO David Bernstein said, an average of about 1.8 ships a year.

Donald, who was in China to sign the shipbuilding deal, said he took away from the trip a renewed sense that the Chinese government has included the cruise industry in its five-year plan. That, he said, suggests support in the way of infrastructure spending, supply-chain growth, training, port development and shipbuilding.

He said the limitation right now comes from Chinese wholesalers unaccustomed to fast growth.

“It’s an embryonic market,” he said. “Distributors are finding their way for the first time with cruise.”

To help educate the Chinese consumer about cruising, Carnival has opened 16 marketing offices in China in the past few years, and another four are set to open in 2017.

“I think the important thing for us in China is to ensure that we are developing sustainable business there,” Donald said. “Sustainable for our distributor partners, sustainable in terms of the government’s desire to have the cruise industry be established there and obviously sustainable for us from a profit standpoint. So it has to be a win-win-win.”

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