Summary
- Royal Caribbean is on track to return to profitability in 2023, with analysts projecting positive EPS for the first time in three years and revenue levels higher than in 2019.
- The pandemic-induced slowdown led to a collapse in cruise line revenues in 2020 and 2021, causing players like RCL to increase debt to survive.
- With an industry-wide recovery underway and a return to profitability around the corner, the debt concerns are proving to be unfounded.
- RCL is attractively valued with its P/S being more than 50% lower than its 5-year average despite revenues expected to surpass pre-pandemic records.
- The company is up 33% YTD but could register more gains as the industry continues to recover amid high consumer demand and expectations that a recession will be avoided.
This is the best January for US stocks since 2019 thanks to falling inflation and investors' pricing in a pause in interest rate hikes. The S&P 500 and Nasdaq 100 as respectively represented by SPDR S&P 500 Trust ETF ( SPY ) and Invesco QQQ ETF ( QQQ ) have clocked impressive YTD gains as the chart below illustrates.
Europe has also had a great January while, further east, renewed optimism about China's reopening has fueled strong gains for Chinese stocks. The new bullish trend in the market after the bearish run in 2022 seems to be sending a signal that the US and global economic outlook is materially improving.
Investors' optimism is shared by economists and experts, including the International Monetary Fund ((IMF)), which updated this year's outlook saying a global recession will probably be avoided. "The global economy will slow down this year before rebounding in 2024. But a global recession is not in our baseline," IMF World Economic Outlook January 2023 Update .
This suggests the markets could continue trending higher. Considering that SPY and QQQ are still down 9.65% and 18.8% respectively from 1 year ago, with P/E's also having come down over this time, the downside risk appears limited. Perhaps it could be time to get more aggressive in names that are positioned to outperform in a bull market.
Doubling down on winners
Everybody has their reasons why they believe a particular stock will outperform and there is no shortage of stocks to consider when the broader market is bullish like now.
In my case, the stock that stands out is Royal Caribbean Cruises ( RCL ). The stock is up 33% YTD, the underlying business's fundamentals have significantly improved and the valuation is reasonable given the current price/sales (fwd) of 1.82x is 56% lower than its 5-year average of 4.18x.
In the interest of full disclosure, I have been bullish on the stock since Q2 2022 and initiated a significant long position in it at the time, writing in an August 2022 article that fears of a recession and concerns over RCL's debt load were overblown. RCL has gone up 70% since publishing the piece, and as a long-term investor, I benefit from a low-cost base. I can therefore get more aggressive now, given my expectations of the upside at current levels and my general investing principle of doubling down on existing winners in my portfolio vs looking for new winners in the market.
Improving fundamentals amid industry recovery
RCL is expected to announce FY 2022 earnings on Tuesday, Feb 7 pre-market, with analysts projecting annual revenues of $8.85 billion, signaling a full scale turnaround after revenues collapsed to $2.21 billion in 2020 and $1.53 billion in 2021 amid the covid-19 lockdowns that restricted travel. Importantly, analysts expect revenues to reach $12.81 billion in 2023, surpassing 2019 pre-pandemic revenues of $10.95 billion. The company is also expected to swing back to profitability in 2023 with EPS of 3.32, ending the three-year streak of losses that were triggered by the pandemic.
When it comes to cruises, passengers tend to plan and book their vacations several months in advance. Bookings and occupancy levels, also known as load factor in the cruise line industry, are therefore important indicators of demand. RCL's load factors steadily increased in the second half of 2022. RCL had a load factor of 82% at the end of Q2. This rose to 96% by end of Q3. During the Q3 earnings call , the company's management provided guidance of triple-digit load factors by end of 2022, meaning demand is higher than available capacity, shifting pricing power to RCL.
RCL's improving fundamentals are likely to translate into improved earnings amid a broader industry recovery. Cruise Lines International Association (CLIA), the world's largest cruise industry trade association, notes in a recent survey that consumer sentiment has significantly improved in 2023. The survey was carried out with 4,500 domestic and international travelers from the UK, France, Germany, Italy, Spain, the USA, Canada, Australia and Brazil. Some notable highlights for UK travelers include:
-
91% of respondents who have cruised previously said they intend to take a holiday at sea again, a 14% increase from 2019
-
Of those who have never cruised, 72% are open to cruising, a 1% increase from 2019
-
Of these two groups, 58% say they will book a cruise in the next two years
Investors are taking note of the cruising industry's improved outlook. Citi recently noted that the cruise line industry is one of the bright spots in the market in 2023, with analyst James Hardiman selecting RCL as his top pick while noting that peers Norwegian Cruise Line Holdings ( NCLH ) and Carnival Corp. ( CCL ) are also compelling picks.
Continue buying
I started buying RCL in the first half of 2022 and paused in the second to see whether my thesis would play out. At the time, I was convinced that the stock was weighed down by irrational fears about the impact of a recession on cruising demand. It's clear now that these fears were overblown as demand for cruising has picked up even as economists note that a recession could be avoided.
Importantly, concerns over RCL's debt levels, which was also another point of concern in early 2022, have proven to be unfounded. RCL's total debt ballooned from $11.79 billion in 2019 to the current $23.94 billion. It's important to note that this debt was taken to put the business on life support during the covid slump and not to fund a risky new venture. With the business now growing amid an industry-wide recovery, and profitability likely to return in 2023, the debt levels will likely be brought down progressively in coming quarters. Improving the balance sheet is one of the top management priorities that was highlighted in recent earnings call.
RCL's current market cap of approx. $16 billion is still significantly lower than pre-pandemic levels despite the business being larger on a topline basis and profitability coming back. Valuation as measured by price/sales - using this metric since it's still clawing its way out of losses, thus making P/E inapplicable - suggests the stock is cheap as the current forward multiple is more than 50% off its 5-year average, even with strong revenue growth projected for 2023.
I bought RCL in January and will keep opportunistically adding to my position in the remaining two months of Q1 2023 as I believe it still has further to run.
For further details see:
Royal Caribbean: Big Opportunity Amid Return To Profitability