Royal Caribbean (NYSE:RCL) has had a nausea-inducing year. The novel coronavirus has absolutely crushed the cruise ship industry in addition to RCL stock. It’s unclear if the major players will even survive at this point; after being excluded from the major government stimulus program, cruise companies have had to desperately look for more capital.
Some traders have rushed into the cruise ship stocks. Analysts are less positive, though, and sentiment around Royal Caribbean has been pretty negative, both here at InvestorPlace and elsewhere. While some authors are optimistic, the majority of folks agree that the stock is pure speculation at this point as the company is seemingly lost at sea. In fact, I generally agree with this view. Last month, I warned that the company’s huge debts would likely sink RCL stock.
All that said, when sentiment is heavily in one direction, it’s worth asking how the crowd could be wrong. If Royal Caribbean makes a comeback, how does it happen?
As our Brad Moon put it, a vaccine is a prerequisite to any possible turnaround; a second-wave of the virus would cripple the cruise companies. But if you assume that we’re past the worst of Covid-19, what’s Royal Caribbean’s comeback plan look like?
Royal Caribbean and RCL Stock as a Premium Brand
During a crisis, it can be helpful to get back to basics. What made Royal Caribbean a good company, and what can they do right now to regain their past glory?
On a branding level, Royal Caribbean tended to position itself as a higher-tier cruise line, offering a more luxurious experience than Carnival (NYSE:CCL) or Norwegian (NYSE:NCLH). Was it a huge difference? No, but it was enough to stand out — Royal Caribbean rarely had to discount voyages last-minute to fill cruises, for example, thanks to its superior branding.
There’s enough there that you can see the impact on the various cruise liners’ financial statements. Carnival has suffered in recent years, with its Returns on Invested Capital (ROIC) gradually falling. ROIC is important because it measures the effectiveness of a company’s capital investments (in this case, new ships) in generating profits.
Carnival’s ROIC fell from 13% in the early 2000s to as low as 5% in the mid-2010s. Carnival’s ROIC recovered a bit the past few years, but has clearly been in a downtrend as it lost some of its competitive edge. Norwegian has historically earned the lowest of the bunch, and has struggled to generate more than 5% consistently.
A low ROIC like Norwegian has, or a falling one, like Carnival, indicates lackluster profitability. If a company borrows money at 7%, for example, and then only earns 5% on its new investments, it’s going to slowly lose money, as it costs more to obtain capital than can be earned from investing it. For example, Carnival recently borrowed money at 11%, yet even in good times, it was earnings a little less than that. Royal Caribbean, with its generally rising ROIC in recent years, has a chance to capitalize on this current mess.
Royal Caribbean is doing the best it can to try to survive this historic bust. And they may just be able to pull off a turnaround. The company has cut spending dramatically. For example, it was able to work out deferments for $1.8 billion of spending on new cruise ships that it had ordered.
While the company is cutting overhead, there is still hope for the future. Bookings for the 2021 cruise season so far are coming in on par with where they were pre-coronavirus. There’s a long time between now and 2021, and who knows how much of that booking activity momentum will be maintained.
As long as there isn’t a huge second wave of the virus, it seems Royal Caribbean will have at least one more shot to impress its customers and sail back toward profitability.
RCL Stock Verdict
Ultimately, I believe the cruise lines are in deep trouble. Their debts are huge, and it’s unclear how long it will take the industry to get back to anything approaching normal. Carnival will be returning to cruising soon, as it plans to get voyages going again on August 1st. I wouldn’t be surprised if that ends up being messy, however, as it’s far from certain that the virus can be safely contained at this point.
By contrast, Royal Caribbean has the opportunity to prove that it is the best-in-class cruise line once again. Deliver the highest-quality service and do so at the utmost level of safety. In recent years, Royal Caribbean earned improved returns on its investments — unlike its two main rivals — as it improved its competitive position. It’s time to push that advantage to the maximum.
Admittedly, Carnival still has the strongest position of the three publicly-traded firms, as it has already raised a large chunk of cash and has the best balance sheet. If Royal Caribbean and RCL stock are going to survive and make a comeback, now is the time to distinguish itself by offering the best product it possibly can. The cruise line that can make passengers feel safe and welcomed again has a chance to be the big winner in coming years.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.