Royal Caribbean Cruises: Finally A Buy Here – Improved Upside Through FY2025 (NYSE:RCL)

We previously covered The Royal Caribbean Cruises (NYSE:RCL) in July 2023, discussing the massive euphoria embedded in its stock valuations and prices, as the cruise line continued to raise its FY2023 profit guidance, thanks to the robust consumer demand.

We had preferred to rate the stock as a Hold then, attributed to the minimal margin of safety with the elevated debt levels remaining a massive headwind.

In this article, we will be discussing why we finally rated the RCL stock as a Buy, with it being the best of breed amongst its cruise line peers, thanks to the management’s prudent deleveraging and interest rate swaps during this time of elevated interest rate environment.

The raised forward guidance has also contributed to the optimistic consensus forward estimates through FY2025, with the management likely on track to achieve its ambitious Trifecta Goal.

We shall discuss further.

The RCL Investment Thesis Has Improved Drastically

For now, RCL has reported an exemplary double beat FQ3’23 earnings call, with revenues of $4.16B (+18.1% QoQ/+39.1% YoY) and adj EPS of $3.85 (+211.5% QoQ/+1380.7% YoY).

This is on top of the raised FY2023 adj EPS guidance to between $6.58 and $6.63, with the midpoint suggesting a YoY expansion of +188.06% from FY2022 levels of -$7.50, despite the headwinds from elevated fuel pricing, forex, and ongoing conflicts in Ukraine/ Israel.

If any, RCL’s robust pricing power is notably observed in its expanding gross margins of 48.6% (+4.1 points QoQ/+12.8 YoY), well above the FY2019 levels of 45.6% (+1 points YoY).

Consumer demand remains strong as well, with deposits of $5.03B (-11.2% QoQ/+33.4% YoY) in the latest quarter, compared to FY2019 levels of $3.42B (+8.9% YoY).

RCL has also consistently deleveraged its balance sheet, with a moderating long-term debt of $17.6B in the latest quarter (-5.7% QoQ/-7.3% YoY), down by -16.1% from the peak levels of $20.98B, though still elevated compared to its FY2019 levels of $8.28B (inline YoY).

Most importantly, the management focuses on the reduction of variable rate debts to $4.59B (inline QoQ/-38.5% YoY), as a way to manage the headwinds from the elevated interest rate environment, with a consistently moderating FQ3’23 weighted average interest rate of 6.40% (-0.76 points QoQ/-0.79 YoY).

As a result, it is unsurprising that RCL’s annualized interest rate expenses have steadily declined to $1.36B (-4.1% QoQ/-3.2% YoY), down from the peak levels of $1.72B, though still elevated compared to FY2019 levels of $408.51M (+22.4% YoY).

For now, the sustained deleveraging also meant that the cruise line’s debt maturities of $3B through 2024 are somewhat manageable, based on the robust cash from operations of $3.36B YTD, with its profitability likely to accelerate based on the booking trends thus far.

These developments have suggested that RCL is in a much better shape than it was some quarters ago, with the robust booking trend and pricing power likely to accelerate its deleveraging and balance sheet improvement.

Combined with its expanding FQ3’23 Net Yields of +16.7% from FQ3’19 levels and FY2023 guidance of +13.15% from FY2019 levels, we believe that things are looking much brighter for the cruise liner, for so long that these trends are sustained over the next two years of uncertain macroeconomic outlook.

A note of warning here.

The Fed has guided a normalized economy only by 2026, with the restart of US federal student loan repayment from October 2023 likely to pose some headwinds to the consumer’s discretionary spending.

For now, North America comprises 57.4% (-5.8 points QoQ/+0.3 YoY) of RCL’s revenues by itinerary in the latest quarter, with it remaining to be seen if the cruise line may sustain the promising booking trends as the industry heads into the winter season.

On the one hand, the impact may not be as severe as expected, since most of its consumers come from a median household income of at least $125K, further aided by the robust labor market and wages. This results in excellent cruise booking levels and doubled pre-cruise purchases through 2024, despite the moderate growth in its capacity by 8%.

On the other hand, investors may want to temper their near-term expectations, especially since the stock is trading at a notable premium, with part of its upside potential already pulled forward.

So, Is RCL Stock A Buy, Sell, or Hold?

RCL Valuations

For now, RCL’s FWD P/E valuation of 15.58x remains elevated compared to its 3Y pre-pandemic mean of 13.05x and the sector median of 14.57x, implying the stock’s notably baked-in premium.

The Consensus Forward Estimates

Perhaps part of the optimism is attributed to the promising consensus forward estimates, with RCL expected to generate a robust bottom line CAGR of +26.1% between FY2023 and FY2025, compared to its pre-pandemic CAGR of +16.2%.

On the one hand, based on the management’s FY2023 adj EPS guidance of $6.60 and the stock’s normalized P/E valuation of 13.05x, the stock appears to be trading above its fair value of $86.13.

On the other hand, based on the consensus FY2025 adj EPS estimates of $10.49, there seems to be an excellent upside potential of +34% to our long-term price target of $136.89.

RCL 5Y Stock Price

For now, thanks to the excellent FQ3’23 results and raised FY2023 guidance, RCL has already rallied tremendously by +27.5% from its October 2023 bottom, with the stock likely to retest its resistance levels of $105s.

However, with the macroeconomic outlook still uncertain over the next two years, we are not so bullish as to project a potential breakout ahead, with the stock likely to trade sideways as it grows into its pulled-forward recovery.

We believe that patient and opportunistic investors may reap great rewards ahead, with the management likely to reinstate dividends when the company achieves its Trifecta Goals by the end of 2025: adj EBITDA per APCD of at least $100, adj EPS of at least $10, and ROIC of 13% or higher.

As a result of the potential dual-pronged returns through capital appreciation and dividend income, we are finally re-rating the RCL stock as a Buy.

Interested investors may want to wait for a moderate pullback before adding, preferably at its previous support levels of $90 for an improved margin of safety.