I have changed my mind about Royal Caribbean Cruises (NYSE:RCL). Given recent developments, I believe RCL stock could be a potential buy. I previously thought, and wrote, that the company was close to failure.
You may recall that I wrote on May 12 that it was sailing close to insolvency. But now I have changed my mind. I want to describe the reasons why, again, I think Royal Caribbean is a potential buy.
I say “potential” because I still think there is a high risk that Royal Caribbean might raise equity capital. So, although I don’t think the company will go under, I still think there is a potential risk to existing shareholders of dilution from a discounted equity raise.
Why I Changed My Mind About RCL Stock
When I wrote that article, I felt that the only lifeline the company really had was its late March short-term loan for over $2 billion. The company raised the 364-day senior secured credit facility from a Morgan Stanley (NYSE:MS) funding group.
But this week, Royal Caribbean was able to pay back and replace that facility with two senior secured notes for $3.32 billion. They have extended the maturity dates much further. For example, $1 billion of the notes are not due until 2023. Moreover, $2.32 billion in notes are due much later in 2025. In addition, the financing effectively raised another $1 billion over the $2.35 billion in Morgan Stanley 364-day notes.
Given that Royal Caribbean is running a cash burn of $275 million per month, the financing effectively gives Royal Caribbean 12 months ($3,320 million divided by $275 million = 12). This pulls RCL stock away from the brink.
I realized that I was wrong about the company not surviving without bankruptcy. I looked more closely at the collateral. The original Morgan Stanley funding was secured by just 28 of the company’s 61 ships.
The company had said these ships had a net book value collateral of $12 billion. Keep in mind that the company’s latest book value of its ships was $26.1 billion, as of Dec. 31. So the company has plenty of collateral. Moreover, the company seems to have plenty of funding options and interested debt funders other than just short term loans.
RCL’s Valuation Ratios Are Not So Bad
I changed my mind for a second reason. The company’s valuation ratios are much better than I had assumed.
For example, as of Dec. 31, 2019, Royal Caribbean had a book value of $12.1 billion. Let’s assume that half of the recently raised liquidity is burnt as negative cash flow until cash flow operations begin. That would effectively lower book value by $1.66 billion to $10.44 billion.
But RCL stock has a market value of $7.83 billion. So that means the stock is trading well below its effective, forward book value. That book value per share is $49.52. At today’s price of $37.45, RCL stock is trading at 75% of its expected book value in six months. That seems to me to be a reasonable bargain price.
Moreover, its debt-to EBITDA ratio (i.e., debt coverage) does not seem too excessively high. For example, in 2019 the company made $3.334 billion EBITDA. Let’s assume in one year, that the company will be on a run-rate for approximately 75% of that EBITDA rate. That puts it at $2.5 billion.
Now, as of Dec. 31, 2019, the company had $10.6 billion in net debt. Assuming half of the recent capital raise is burnt off as negative cash flow ($1.66 billion), the net estimate net debt is $12.26 billion.
Therefore, the net debt-to-EBITDA ratio, on an estimated basis is roughly 4.9 times ($12.26 billion divided by $2.5 billion). That is not too extreme. It certainly is not in bankruptcy territory. Barron’s said in a recent article that FactSet had put the debt coverage ratio at 3.5 times at the end of 0f 2019.
Watch Out for Potential Equity Raise
My numbers are just estimates. There is still a significant risk that the company may want to bolster its capital, once the stock rises, to raise permanent capital.
This means that once it is clear that operations can begin and the company produces cash flow it might want to raise say $500 million to 700 million or more (10% of its market value) in common stock.
But, here is something interesting. Even though the stock trades at book value now, if the stock were to rise in say several months to book value, the company might be willing to raise equity at that price. They could claim that the capital would not dilute existing shareholders’ equity. (This would be true even though there would still be dilution to the equity share count, and any particular shareholder’s stake in RCL.)
Since I estimated book value will be $49.52 per share, it is possible that one might consider Royal Caribbean a buy up to that book value per share. This represents a potential gain of 32% from today’s price.
However, think about this. What if the stock rose to book value and the company decided to make the offer attractive to investors by raising the equity at a discount to book value. Even if that occurs, I believe that RCL stock, trading at 75% of estimated book value per share today, represents reasonable value. In other words, today’s price probably represents the worst price that might occur if the company decided to offer common stock at a discount.
The Bottom Line with RCL Stock
So, here is my point. Royal Caribbean might now represent a good potential buying point for aggressive investors. Once the company announces its March quarter earnings, it will be easier to assess its net book value in six months. If you are willing to take a risk, RCL stock is a potential buy.