Morningstar analysts have raised their valuation for the world’s largest cruise company. 
Carnival (CCL) has 100 ships in service and passenger capacity of around 200,000, allowing it to reach a diverse group of consumers in a segment of the travel and leisure industry that’s only lightly penetrated.
Morningstar's Jaime Katz has increased her fair value estimate for Carnival to 2,658p per share from 2,514, largely due to exchange rate fluctuations. She notes that: "Early indications of first-half 2015 booking and pricing trends appear solid despite some weakness in pricing persisting throughout the Caribbean." Katz expects to see an up-tick in the firm's 2015 expenses as projects in the pipeline will see more ships in the dry dock, but longer term she believes the company will resume strong free cash flow growth as yield growth stabilises and costs revert to more normal levels.
Carnival has protected itself well from competition, enjoying a sustainable competitive advantage that has earned it a 'narrow economic moat' from Morningstar. This moat rating is awared on the back of the cruise operator's efficient scale, cost advantages and intangible brand assets. Carnival has captureed about half of the total current capacity in the cruise market, and together with the other largest industry player controls nearly 75% of the global market. "The significant share of capacity that is represented by these two companies is enough to prevent most would-be rivals from entering the marketplace and directly competing with the incumbents," Katz says.
In addition to Carnival's ability to capitalise on under-served markets such as Asia Pacific and Latin America, where Katz believes it could succeed in the years ahead, a key factor in our investment thesis is the ageing population in the western world. "We expect the 65 and older demographic to grow more than 16% between 2015 and 2020 (based on census data), while overall cruise industry capacity grows around 3%," says Katz. "Additionally, the repositioning of a few ships to Asia Pacific lowers supply in regions like the Caribbean, which should allow Carnival to implement more lucrative pricing strategies globally."
On the downside, the Carnival faces a number of inherent risks that may affect its share price value, including headline and media risk that could frame the business poorly, as it did in 2012 and 2013; the squeezing of the middle classes in the US and UK impairing demand for cruise holidays; volatility in the price of fuel that could impact profitability; and, longer-term, potential erosion of profitability as a result of changes to the firm’s tax status in the US.
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