- Investors should focus on Royal Caribbean's Enterprise Value instead of its share price. By this measure, the company is already back to pre-COVID levels.
- I expect the recovery in cruising to be slow after an initial burst fueled by pent-up demand from frequent cruisers.
- Operational cash burn was $900 million in Q1. A similar level is expected in Q2, and they will almost certainly burn cash for the rest of the year.
- April featured significant insider selling at prices between $88-91.
Royal Caribbean (NYSE:RCL) has seen a tremendous recovery, more than tripling off the lows set last March and April. But by now, I think the recovery trade is overdone and shares are set to languish in the foreseeable future.
Current Share Price and Valuation
Many of the bullish arguments I've read for the cruise lines, including Royal Caribbean, have boiled down to little more than
"Cruise Lines Reopening = Profit!"
with associated excitement from positive management commentary on booking trends as the key support. Indeed, there will certainly be many positive headlines over the next several months as we slowly return to normalcy and cruising resumes. But I believe this enthusiasm is fully priced in (and then some) by now.
Some investors are looking at the share price chart and concluding that Royal Caribbean will head back to the $110 range shortly after cruising is allowed to resume. Unfortunately, they are looking at the wrong chart.
We can't compare pre-COVID Royal Caribbean to post-COVID because of the number of shares and the amount of debt the company has issued. For a better comparison, we should focus on Enterprise Value, which factors this in by summing market cap with net debt.
Viewed this way, RCL has already recovered to pre-COVID levels, which is amazing since RCL is still burning $250-300 million per month, will burn this much at least through July, and will almost certainly burn cash every month this year. RCL will likely end 2021 with ~$2.5 billion less cash than they have now.
Going forward, the increased share count and debt levels will weigh on the share price.
Impact of additional shares: Royal Caribbean has 243 million outstanding shares now, compared to 209 million pre-COVID. $1 in EPS before COVID is now 86 cents with the increased number of shares.
Impact of additional debt: In 2019, RCL had $2.1 billion in operating income with $408 million in interest expense.
Debt has risen from $8.3 billion in December 2019 to $20.7 billion now. Interest expense will be near $300 million/quarter by the end of Q2.
Even if RCL can get back to the same peak operating income by 2023, they still face over $1 billion in annual interest expense compared to $400 million pre-COVID.
Between the additional debt burden and the increased share count, earnings per share will be cut in half with the same operating performance, and investors will have to wait almost 3 years to get to this level.
Looking at the stock price in a vacuum without accounting for this is a fool's errand.
COVID vaccination and herd immunity leading to a travel boom is an extremely consensus theme in the market. I believe it is priced in, and then some, with travel companies like Booking.com (BKNG) above pre-crisis highs. In Booking's case, this may make some sense as the pandemic showed how resilient a business it is. In the worst possible scenario for travel, Booking still managed positive net income in 2020.
Royal Caribbean has lost $6.9 billion in the past 5 quarters, which is more than they've earned since 2015. Of all the various travel and entertainment sectors, I believe cruise lines will be near the last to fully recover.
Demographics and Social Distancing
Cruises skew towards an older demographic, with half of cruisers being 50 years of age and older. The 20-49 crowd is only 35% of all cruisers. I think it's reasonable to believe this 50+ demographic may be more concerned with crowded spaces for a long time.
Many health-conscious travelers already avoided cruising because of norovirus outbreaks and other disease-related concerns. When you look at the data from the CDC, these concerns are overblown, but most people don't look at data and perception becomes the reality. I think the same thing could happen going forward with COVID-19, where fear among older travelers that are vaccinated outweighs the actual risk.
Social Distancing is going to be difficult on a cruise ship at anywhere near full capacity. Most cruise ship hallways are ~3 feet wide; it's tricky for two larger people to walk past each other. Crowds are common in entrances for dining and events, at buffets, and in the casinos.
Cruise operators will certainly employ every mitigation possible, but the fact remains that cruise ships are just not built for distancing.
Next, we have the current vaccine requirements which require proof of vaccination. While American attitudes towards COVID vaccination have improved in recent months, there is still a large percentage of the population that does not want to receive it.
Bookings should be strong initially as frequent cruisers return after an 18-month hiatus. But after that, I think the return of the broader mass market will be slower than many investors think.
In the short term, I expect cruise executives to remain upbeat. They still need to raise capital both to fund operations and rollover debt, and with the recovered share price, I believe they will favor equity raises. Expect them to paint an optimistic outlook, even as they are cashing in their own shares.
Later this year into early next year, I think this optimism fades and the reality of the challenges facing the cruise recovery becomes apparent.
Outlook and Conclusion
At this point, almost all of the good news is out. It's widely expected that cruising will restart at some point later this summer. Judged by enterprise value, the appropriate measure, the cruises have already fully recovered to pre-COVID levels. Where's the upside?
I believe there is significant risk to the shares here over the next few quarters as the reality of how long and slow the cruise recovery will be, even under the best conditions. When you then factor in the small but real tail risk of another COVID variant emerging that current vaccines are not fully effective against, I believe shares are a clear sell.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in RCL over the next 72 hours. 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.
I would consider shorting RCL if the price rose into the mid $90's.
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