This post was written on 10 March 2020. When the post is published, it will be interesting.

The analysis is separated into two parts. The first part assumes Covid-19 never exists and evaluate whether RCL is a preferred stock to invest. The second part looks at whether RCL is tough enough to overcome the impact of Covid-19. The rationale is that Covid-19 is temporary. If RCL is worth investing without Covid-19 and it is tough enough, given the current price, RCL may be a good opportunity.

About Royal Caribbean Cruises

Royal Caribbean Cruises Ltd. is the world’s second-largest cruise company with 60 cruise ships in service, totaling 135,520 berths and 16 ships on order as of 12/31/18. It owns four global brands: Royal Caribbean International, Celebrity Cruises, Azamara Club Cruises, and Silverseas Cruises. In addition, it has a 50% investment in a joint venture with TUI AG and a 49% interest in Pullmantur. Employees: Approximately 77,000. Significant stock-holders include Vanguard, 8.5%; Osiris Holdings, 5.4%; officers and directors (including Arne Wilhelmsen), 13.1% (4/19 proxy). Chairman & Chief Executive Officer: Richard D. Fain. Incorporated: Republic of Liberia.

What if there is no Covid-19?

Basic Statistics

10-year sales data shows that sales is improving with both 5-year and 5-year median growth of 4%.

Not only its sales is improving. The profit margin maintained before 2014 and improved after 2014. 30% net profit margin is impressive.

The rate of earnings improvement is higher than that of sales which indicates RCL improves on managing costs. But there may be rooms for manipulating the depreciation of cruise ships. Let’s review the depreciation too.

Depreciation expenses generally follow the trend of sales which makes sense to me since the more customers use the ship, the more the ship should be depreciated.

Because of the good performance, the 5-year median dividend per share is 2.16 and the 10-year median dividend per share is 1.35.

Valuation

Usually, I divide cash flow from operating activities by the required rate of return to get the valuation of the stock. Then I will compare Earning Yield and Dividend Yield with Bond Yield to have a feeling on whether the stock is expensive or not.

USD in Billion20192018201720162015
Cash flow from operating activities3.723.482.872.521.95
Shares Outstanding0.21

If the required rate of return is 10, the valuation of RCL will be USD 136.7 \frac{2.87}{0.21*0.1} which is quite close to the price in 2019. If we use the year 2015 figure, the valuation will be USD 92.8 \frac{1.95}{0.21*0.1}. Both 2 figures are higher than the current price of 48.27.

A more detail analysis should also include maintenance capital expenditure (capital expenditures that are necessary for the company to continue operating in its current form) in the cash flow formula since ships needed to be maintained.

To calculate the maintenance capital expenditure, I use Bruce Greenwald’s Method. The method is simple. We calculate the average PP&E needed for each dollar of revenue. Multiply this with the revenue growth and get the PP&E needed to support the growth. Minus this number with capex and get the maintenance capex.

Billion USD20152016201720182019Median
Gross PP&E26.2228.1427.7832.4436.2428.14
Total Revenue8.38.58.789.4910.958.78
PP&E/Revenue3.1590361453.3105882353.1640091123.418335093.3095890413.309589041
Revenue Growth0.20.280.711.460.495
Capex-0.06-0.01-0.01-0.01-0.03-0.01
Maintenance Capex0.67211764710.89592255132.4370179144.8621.648246575

Our estimation is higher than the depreciation expense of 1.25.

Using the average maintenance capex, the valuation will become USD 58 \frac{2.87-1.65}{0.21*0.1}. Still, it is above the current price. If we want to be harsh, we may use the year 2015 cash flow from operations, this gives USD 14.2.

Using the 5-year median EPS (7.53), the current earnings yield is 15.6% which is high. Using the 5-year median DPS (2.16), the current dividend yield is 4.5% which is acceptable (depends on your preference).

Liabilities and Leverage

Negative working capital may not be a bad thing is the cruise ship industry since the business can generate cash quicker than pay its bill to the supplier. It is quite common for a cruise ship company to have negative working capital, for example, Carnival Corp.

  • Around half of the current liabilities is deferred income which means prepayment made from selling tickets.
  • The current leverage ratio is around 1.5 (\frac{18.16}{12.16}).

With reference to S&P 500 average leverage ratio, it seems that 1.5 leverage ratio is high. In fact, it is higher than any of the leverage ratios of S&P 500 from 1994.

Can RCL Survive and Recover?

This is really hard to tell since it depends on the development of Covid-19 and how long it will last.

One of the matrix to evaluate bankruptcy risk is Altman Z-Score. It makes use of five ratios, namely, working capital/total assets, retained earnings/ total assets, earnings before interest and tax / total assets, the market value of equity/ total liabilities, and sales/ total assets. This website explains very well on Z-score.

The current z-score of RCL is 1.21, indicating it is in distress zone. According to Guru.com, the historical z-score of RCL is as follow:

Dec 2015Dec 2016Dec 2017Dec 2018Dec 2019
z-score1.861.712.341.61.8

It indicates that RCL is consistently very close to distress probably due to its negative working capital which usually may not be a concern.

Negative working capital is of concern under Covid-19, especially when 50% of current liabilities is deferred income. If customers cancel their trips, it will affect the ability to fulfill the short term liabilities.

Under my current assessment, I do not feel comfortable investing in RCL due to the likelihood of financial distress and negative working capital. However, the greatest uncertainty is how Covid-19 will develop. If RCL can survive, it is a good stock to have. (Although it sounds like a gamble on Covid-19)

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