When the equity markets were in a meltdown mode, Royal Caribbean Cruises (NYSE:RCL) plunged to $19.25. But RCL stock doubled from the lows and trades at $39.47. This has been in line with some respite for the broad markets.
At current levels, I believe that it might not make sense to consider fresh exposure to the stock.
Before I deal with the concerns, I want to mention one point that makes Royal Caribbean worth considering on correction. As of fiscal year 2019, the cruising industry market penetration for North America was 3.89%. For Europe and Asia Pacific, the penetration was 1.41% and 0.2% respectively. Clearly, industry penetration is low and according to the company, a significant portion of “cruise guests carried are first-time cruisers.”
This presents a huge opportunity for Royal Caribbean Cruises in the long term. A very basic assumption is that the novel coronavirus is contained and the world is back to normal activity. Therefore, I am bullish on RCL stock beyond the current headwind.
I would also like to point out that the company operated 61 ships as of December 2019 with 17 ships on order. The order book is an indication of the impending demand for cruising. Growth will be hampered in the medium term, but the trend is likely to remain positive for the industry.
Significant Near-Term Challenges
Even as there is hope for growth in the long-term, the markets are likely to focus on the upcoming challenges. This will keep RCL stock depressed.
As a first point, Royal Caribbean Cruises announced suspension of cruising in the second week of April. Recently, the company updated that cruising will remain suspended until the second week of June. Therefore, the company has already lost one quarter and the first quarter of 2020 is also likely to disappoint. Furthermore, there is no assurance that cruising will resume after the second week of June. Even if it does, I believe that occupancy will be dismal.
The director of the Centers for Disease Control and Prevention warned that a second wave of coronavirus is likely to be even more devastating. This prediction is for winter. This will leave consumers more cautious. A second lockdown cannot be ruled out later this year.
Overall, it’s certain that the year will be disappointing for Royal Caribbean. As recovery is delayed, the stock will trend lower.
Leverage Is Likely to Increase
I also want to focus on the company’s liquidity profile. The reason is that for the current year, the company has $5.5 billion in contractual cash obligations. This includes ship purchase and debt obligations.
In March 2020, Royal Caribbean Cruises entered into a $2.2 billion 364-day secured term loan facility. This enhanced the company’s total liquidity position to $3.6 billion. Further, the company mentioned that it has committed financing for all of its new ships on order.
Therefore, near-term liquidity should not be a problem, but the company is likely to leverage further for capital expenditure. In addition, the company has nearly $4 billion in contractual cash obligation for the next two years. Therefore, liquidity pressure is likely to sustain.
I will be worried if the crisis extends beyond the current year, or if cruising recovery is very gradual. As the company leverages, cash flow is critical for survival.
RCL stock currently pays an annual dividend of $3.12 with a dividend yield of 8.5%. With cash conservation in focus, I will not be surprised if there is a deep cut in dividends. This is another factor that can trigger downside for RCL stock.
The Bottom Line on RCL Stock
The cruising industry will take time to recover. The coming quarters will be associated with a weakening of credit profile for Royal Caribbean. This will impact stock sentiments.
Cautious travelers will further prolong the recovery prospects and I certainly don’t see a V-shape industry recovery.
While I am bullish on the long-term outlook for the industry and the company, RCL stock can be avoided at current levels.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.