Royal Caribbean: Strong Buy

| About: Royal Caribbean (RCL)

Summary

The cruise liner industry is experiencing strong tailwinds from the rise in Chinese tourism.

We expect these tailwinds to become even stronger over the next decade as Chinese consumers become wealthier.

We think Royal Caribbean is positioned perfectly to profit.

If oil prices remain subdued, Royal Caribbean could be a great long-term investment.

Due largely to the incredible rise of its middle class and its love of traveling the world, the China market has been touted as one of the major growth opportunities for the global cruise liner industry. Not only has the country lived up to expectations so far, but it looks set to continue growing at a rapid rate for the foreseeable future. As one of the world's leading cruise liners, we believe Royal Caribbean Cruises (NYSE:RCL) is in a strong position to profit.

For a good number of years now China has been the focus of many international businesses that are looking to capitalize on a growing economy filled with consumers who enjoy the luxuries in life. With China's middle class and affluent class continuing its incredible rise, it's no surprise to see luxury retailers scrapping it out for supremacy in the world's second-largest economy. But these retailers are certainly not the only ones looking to capitalize on the emerging middle class.

As China's middle class has grown, so too has its love of traveling. One area of the travel market that has benefited has been the cruise liners industry. An ever-increasing number of Chinese tourists are opting for cruising, so much so that the world's biggest cruise liners have adjusted their business models accordingly to accommodate this lucrative market. Two recent examples of this include Royal Caribbean's decision to remove South Korean sites from certain cruises due to a political row between it and China, and the company's plan to build China-centric ships.

Is it worth it? We think so. According to the company's most recent 10K, Asia-Pacific provided approximately 15% of global cruise guests in 2016. Thanks largely to Chinese growth, the number of global cruise guests from the Asia-Pacific region has grown at a compound annual growth rate of 25% from 2012 to 2016. Impressively, we feel confident this level of growth can continue for some time to come. One only needs to look at the estimated market penetration to see this.

Source: Company 10K

As of last year, just 0.09% of the Asia-Pacific market had been penetrated. Whilst we don't necessarily expect to see it ever reach the same level of penetration as North America, we do believe there is reason to believe it could grow beyond 0.3% in the next decade. That is roughly equivalent to 13 million passengers, almost in line with North America's passenger numbers. As official forecasts by the Chinese Ministry of Tourism predict that there will be 4.5 million cruise liner passengers in China by 2020, we don't think it is too far-fetched to believe that the whole region could provide 13 million passengers by 2027.

But Royal Caribbean will only profit if it can capture this growth. It's all well and good simply saying the industry will grow, but there's a little more to it than simply docking in and shouting all aboard. We think the company's decision to build China-centric ships will prove to be a fantastic one. We feel these ships will attract increasing numbers of passengers, and then maximize their spending once on board.

So is it time to invest? We think that the long-term tailwinds from Chinese tourism mean Royal Caribbean is a great long-term investment option. Especially with our view that oil prices will remain subdued for a good number of years. Being a cruise liner, the company does of course consume a large amount of fuel. This year, for example, according to its 10K, Royal Caribbean expects to consume 1,332,000 metric tons of fuel at a cost $704 million. As a result, an oil price that stays lower for longer means fatter margins and increased profitability. Although OPEC aims to cut production to tackle the oil surplus and boost prices, we agree with the view that prices will remain in or around the $50 a barrel for the foreseeable future. Whilst we are skeptical that OPEC and Russia will fully comply with its output cut promises, the main reason for subdued prices, in our opinion, is rising production in the United States. In February, domestic stockpiles recorded their ninth consecutive month of supply rises to reach 8.2 million barrels.

Because of this, we feel Royal Caribbean will hit the top end of its earnings guidance range of between $6.90 and $7.10 per share. Based on this and our opinion that an earnings multiple of 16 is fair, we have a 12-month target price of $113.60 for the cruise liner giant. Should its share price reach this level it will mean a return in excess of 15%, or 17% including its 2% annual dividend. Although rising tensions in the Asia-Pacific region is a risk worth considering, we believe that an investment in Royal Caribbean provides investors with a compelling risk/reward at the current share price.

Disclosure: I am/we are long RCL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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