If you own Royal Caribbean (NYSE:RCL) stock, you must be feeling like Michael Corleone in Godfather III at this point.
In the much-reviled final installment of the iconic trilogy, the character famously says, “Just when I thought I was out, they pulled me back in,” as his mafia pals ensure he can’t go straight. RCL management may be feeling something similar at this point.
The cruise line was hoping to set sails on Aug. 1, but those plans have changed, and now the company aims to resume operations on Sept. 16. Coronavirus cases are spiking in the U.S. once again, and cruise lines are bearing the brunt of this development.
Moody’s has put the entire cruise line sector on review for downgrade. Meanwhile, Macquarie downgraded Royal Caribbean, Carnival Corp. (NYSE:CCL), and Norwegian Cruise Line Holdings (NYSE:NCLH) to “neutral” from “outperform.”
Year-to-date, RCL shares are down 60%, but they still trade at a price-earnings ratio of 66, a steep premium to the sector median of 23. So, there is some correction that will happen within the coming weeks that should push the stock down further.
Overall, it looks like 2020 will be a bleak year for the company. Here’s hoping the next year brings normalcy and profitability to the cruise operator.
The Novel Coronavirus Pressures RCL Stock
California Gov. Gavin Newsom recently ordered several sectors to shut down again due to a surge in Covid-19. A majority of them have to do with outdoor operations. The decision was met with mixed responses, but it highlights the sensitivity of the current situation.
Every state would want to make sure they are not risking the lives of their citizens by keeping things open when cases are increasing. In such an environment, it’s understandable why administrations would focus on cruise lines in particular.
It could not have come at a worse time, though. Many cruise operators were targeting to resume operations in the fall, but no-sail orders could extend far into 2021 if Covid-19 issues persist.
In my previous piece on RCL, I mentioned how the company had done well to gather capital to make sure it survives this crisis. I don’t see liquidity as a significant problem at this stage, but what has piqued my interest is RCL’s appetite for expansion even at this stage.
In a surprising move, the cruise operator purchased the remaining one-third stake it did not hold in Silversea Cruises. Royal Caribbean paid Heritage Cruise Holding for 5.2 million shares to acquire the stake, so no cash changed hands. Still, it’s an ambitious move considering the bleak outlook cruise lines are facing.
Just to draw a comparison, Carnival recently announced plans to scrap or sell 13 cruise ships and delay new deliveries. The move was met with a positive reaction from the broader markets because scaling down operations will help reduce cash burn.
Despite the bearish outlook, RCL has chosen to go down a different route. It is optimistic about the sector; the Silversea acquisition is evidence of that fact. Royal Caribbean leads its industry, so management knows what they are doing, but it will take time for these benefits to materialize.
RCL Stock Valuation
As I mentioned before, RCL stock trades at a P/E ratio of 66, which is very high. My calculations indicate that the intrinsic value of the company’s share price is $27.22 per share. I’ve taken the company’s current weighted average cost of capital (WACC) as the discount rate. Rates for the growth and terminal periods are 20% and 4%, with time horizons of 10 years each.
Bear in mind that the share price is based on the company’s latest quarterly EPS, which has taken a hammering due to recent events. Revenues are expected to normalize next year, and analysts predict they will rise quicker than RCL’s peers, which is a heartening sign. However, until then, valuations will remain stressed.
The Bottom Line on RCL Stock
It’s no surprise that cruise stocks are under the hammer. With Covid-19 still looming large in the background, RCL stock will remain a risky proposition for the foreseeable future. Once cases are down and we get closer to a Covid-19 vaccine, RCL stock will start to erase its losses. Still, even the recovery will take time, and it’s not like things will instantaneously improve with a vaccine.
Any way you slice it, it seems RCL will have to sail through murky waters before its stock starts to rise again.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. He does not directly own the securities mentioned above.