Improving EBITDA Growth Set to Persist at Royal Caribbean With Full Fleet Deployed

Business Strategy & Outlook

Travel constraints and coronavirus hesitancy are receding, so consumer behavior about travel and social distancing have returned to normal for Royal Caribbean, leading to positive operating cash flow and EBITDA at the business. The redeployment of the fleet is complete, and cruise operators have successfully implemented health protocols to ensure the safety of the cruising population (as evidenced by a lower positivity rate than on land). With virus restrictions largely in the rearview mirror, Royal Caribbean should see modest pricing gains as it digests bookings paid for with future cruise credits and takes new reservations. On the cost side, some health protocols and cruise resumption costs could remain high in near-term spending, but should pare back in 2023, aiding profitability. These factors should lead to average returns on invested capital, including goodwill, that are set to languish below the weighted average cost of capital estimate (9.5%) through 2025, supporting no-moat rating.

While Royal Caribbean has carved out a compelling position in cruising thanks to its contemporary product, it still has to compete with other land-based vacations and discretionary spending for share of wallet. This could intermittently jeopardize top-line growth during transitory periods of land- and sea-based holiday discounting. Royal Caribbean reduced operating expenses and capital expenditures as a result of COVID-19. It also accessed significant liquidity, most recently raising $1 billion in debt in January 2022, to secure its ability to service debt coming due. With $4.2 billion in customer deposits as of June 30, modest liquidity risk exists, as more than $5 billion in debt maturities due in 2023 will force the company to actively seek refinancing. While Royal Caribbean is set to return to positive EPS in the third quarter of 2022, one doesn’t believe either yields or passenger counts will revisit 2019 levels until at least 2023. This should allow Royal Caribbean to generate positive EPS consistently in 2023 and beyond.

Financial Strengths

Royal Caribbean has taken numerous steps to ensure financial flexibility despite headwinds stemming from COVID-19. In March 2020, Royal Caribbean noted it was taking actions to reduce operating expenses and capital expenditures by the tune of $1.7 billion to improve liquidity. Additionally, since the beginning of the pandemic, the firm secured around $17 billion in liquidity through various debt and equity issuances. Furthermore, as of June 30, more than $4.2 billion in customer deposits were still available for use, a decreasing portion of which should represent shift and lift fares as consumers redeem their future cruise credits. Royal Caribbean has been able to amend the majority of its export-credit backed loan facilities to incorporate an extension of debt payments and a waiver of covenant compliance, helping to moderate cash demands, although payments are slated to pick up again in 2023. On the operating expense side, at the start of the pandemic Royal Caribbean’s executives took a pay cut and Royal Caribbean laid off or furloughed more than 25% of its 5,000 shoreside employees. Such efforts helped preserve capital during that difficult time, but have now fully reversed as the industry has redeployed the fleet. The surmise costs per diem will return back to 2019 levels in 2023. The company should be back to consistently positive cash generation in 2023, as restaffing and redeploying efforts are largely complete (which had been a key expense in the $300 million-plus monthly cash burn during the ramp up). With the cash on hand, the Royal Caribbean should have no near-term going concern issues, thanks to 100% of its capacity back on the seas in the summer of 2022, with full occupancy by year-end.

Bulls Say

If COVID-19 regulations continue to pare back quickly, yields could rise faster than expected as demand rises.
The normalization of fuel prices could help benefit the cost structure, thanks to Royal Caribbean’s floating energy prices (with only about 50% of fuel costs historically hedged).
The nascent Asia-Pacific market should remain promising post-COVID-19, as the four largest operators previously had capacity for nearly 4 million passengers at the beginning of 2020, which provides an opportunity for long-term growth with a new consumer when cruising resumes in the region.

Company Description

Royal Caribbean is the world’s second-largest cruise company, operating 64 ships across five global and partner brands in the cruise vacation industry, with 10 more ships on order. Brands the company operates include Royal Caribbean International, Celebrity Cruises, and Silversea. The company also has a 50% investment in a joint venture that operates TUI Cruises and Hapag-Lloyd Cruises, allowing it to compete on the basis of innovation, quality of ships and service, variety of itineraries, choice of destinations, and price. The company completed the divestiture of its Azamara brand in the first quarter of 2021.

(Source: Morningstar)

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