Royal Caribbean (NYSE:RCL) shares have shed 70% of their value since last year. With no-sail orders in place throughout the United States and Europe through July, cruise lines are finding ways to preserve their liquidity so that they are in good shape to potentially return this summer. Uncertainty looms over the resumption of business for RCL stock, but executives are hoping the company can restart operations before 2021.
With virtually no revenue since mid-March, RCL is burning between $250 million and $275 million a month while its operations are suspended. To mitigate costs, the company has cut more than 5,000 of its employees, a number which is expected to grow under a prolonged recession scenario.
According to Zack’s Investment Research, earnings estimate for the upcoming quarter is a loss of 58 cents, which is a 145% decrease from the year-ago quarter. Let’s dive a little deeper as to why I believe that RCL stock will struggle for the foreseeable future.
Stabilization Period
Initially, analysts believed the ban on cruises was a temporary reaction to the coronavirus — one that would be lifted soon. With countries such as China, Taiwan, and South Korea controlling the virus within a couple of months, it seemed plausible Western countries would also come out of the pandemic within a few months. However, now it seems that the timeline is likely to lengthen moving forward. Unfortunately for RCL, the U.S. and European markets are the bulwarks of its revenues.
Most Western countries have not recommended wearing masks in public. The fixation with social distancing and the medical, rather than the sociological, benefits of wearing masks is likely to continue in these countries, making it extremely difficult for cruise companies to return this summer.
Furthermore, a typical cruise itinerary covers a variety of destinations, which further complicates matters. Most of those destinations are likely to implement mandatory quarantine for foreign arrivals. Therefore, it seems that cruise lines cannot return to normalcy until the virus is near eradication. That can only happen if a vaccine is widely available for the disease.
Though details about the resumption of business are unclear, booking volumes for the next season are looking good. RCL’s management states that “Although still early in the booking cycle, the booked position for 2021 is within historical ranges when compared to the same time last year.” Additionally, 55% of customers have chosen to go with a cruise credit instead of a cash refund.
Worrying Liquidity Position
Before the pandemic, RCL was considered to be somewhat of a growth company. Revenues were increasing at a healthy rate each year, and gross margins averaged 42.6% over a five-year horizon. It was the best performing cruise company, with a higher average return on equity than its main competitors Norwegian Cruise Line Holdings (NYSE:NCLH) and Carnival Corporation (NYSE:CCL). With a substantial increase in net income each year, the company adequately plowed back a significant portion of its earnings to expand and upgrade its fleet.
However, on the liquidity front, it is an entirely different story. Financial leverage has averaged 2.42 for the past five years, which is significantly higher than the industry average. In addition, the company has struggled with its short-term liquidity, as its current liabilities have outpaced current assets for the past five years. With everyone rechecking their books for any excess debt these days, the numbers don’t instill confidence.
RCL closed April with $2.3 billion in cash and cash equivalents and has added a $150 million senior secured credit facility in May. RCL and other cruise companies have been unsuccessful in getting any relief from the U.S. government, and have turned to countries such as Germany, who are offering debt holidays for a year. With roughly $2.45 billion in cash equivalents and the monthly cash burn at $250 million, the company can survive approximately ten months without revenue.
RCL Stock Valuation
Cruise line companies have witnessed a massive decrease in their stock price since last year. RCL stock is down 70% from the previous year, while Norwegian Cruise Line and Carnival are down 79% and 72%, respectively. It currently has an earnings rating of 4, which is 10% lower than the industry average and 62% lower than the S&P 500 index average.
According to Refinitiv, in the past 90 days, the consensus price target for RCL has decreased from $143 to $79.10, a loss of -44.7%. However, this price is roughly 107% higher than the current price at $38.
Stock valuation using the P/E ratio suggests that the current price is in line with the earnings multiple. Therefore, the significantly high price estimates are surprising. Perhaps the feeling is that RCL will be able to fend off the crisis and return to safer waters in September. However, even if the company manages to mount a comeback in the summer, demand is not likely to return to the pre-pandemic levels until a vaccine is made widely available.
Final Word
Covid-19 has turned the tables on an otherwise profitable business in the Royal Caribbean Cruises. RCL has a couple of billion dollars to help keep it afloat until demand returns to the pre-pandemic levels. However, it seems that the company’s primary target markets are in for the long haul with the pandemic.
Executives are positive about returning to the seas this summer, but at the current rate, it seems unlikely. Nonetheless, with its current valuation and a proven track record of generating higher returns than the industry, it could be an excellent time to grab the stock at a bargain. However, with the uncertainty surrounding the crisis, I would probably play the waiting game until things become clearer.
As of this writing, Muslim Farooque did not hold a position in any of the aforementioned securities.
