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Morningstar | Royal Caribbean Commentary Allays Fears of Pricing Slowdown in 2019; Shares Fairly Valued

Narrow-moat Royal Caribbean closed another quarter with an enviable booked position, which was at record levels in both price and volume across its fleet. We think Royal’s commentary, which similarly saw U.K. uncertainty, largely parted way with narrow-moat Carnival’s experience noted in March that indicated less favorable pricing trends across the U.K., parts of Europe, and Alaska. In our opinion, this confirms the thought that while rising tides lift all ships (given the healthy U.S. consumer), each cruise operator has idiosyncratic factors that impact profitability, and Royal has most opportunistically capitalized on pricing (via revenue management and itinerary optimization) and cost controls in recent years. We surmise the vast innovation and customer-experience-focused efforts Royal has initiated will help elevate the business to capture best-in-class consumer spend, driven by strong onboard offerings.

Royal lowered its full-year EPS guidance to $9.65-$9.85 (from $9.75-$10 prior) as a result of a $0.50 headwind from a drydock accident with Oasis alongside rising foreign exchange and fuel costs. This implies that excluding these factors, the company could have earned $10.15-$10.35 in EPS, raising its prior forecast, given strength in the underlying business. While we expect to reduce our current $10.00 EPS estimate to reflect these updated expenses, we don’t think it precludes 2020 from achieving its 20/20 Vision goal for generating double-digit EPS, with our prior forecast calling for $10.75 in EPS. Furthermore, we still believe Royal can extract EBITDA expansion from growing as-reported yields just 2% and costs around 1.5%, leading to a terminal EBITDA metric of nearly 34%, up from 31% in 2018. In this vein, we don’t plan any material change to our $133 fair value estimate and view shares as fairly valued, trading at 13 times the midpoint of 2019 guidance, versus our 12% EPS growth over the next five years.

First quarter as-reported yield growth of 7.2% was well ahead of our 6% forecast, bolstered by the addition of Silversea and Terminal A, as well as strong close-in demand, generating the fastest first-quarter pricing growth post-recession, with both ticket and onboard rising 7% on an as-reported basis. Even excluding the more than 300 basis points in benefits from Terminal A and Silversea, this would imply nearly 4% as-reported organic yield growth, solid performance on top of 7% growth in the year-ago period. Net cruise costs, excluding fuel, increased 8.7%, slightly slower than the 9%-9.5% the company anticipated, helped by timing of expenses. However, the better pricing and lower costs, along with improved performance at the company’s joint ventures (TUI, Pullmantur) allowed the company to beat its $1.10 estimate (and our $1.07 forecast) by $0.21, delivering $1.31 in EPS during the quarter.

We still think Royal has the opportunity to surprise investors on the upside with untapped efforts at CocoCay, set to be fully operational shortly. With 2 million passengers set to visit the island in 2020, this captive traveler could bolster onboard spend to new heights (for reference Royal carried around 6 million passengers in 2018). And with commentary that capacity could bear up to 3 ships per day (rather than 2 ships), revenue opportunities abound. Furthermore, the incremental investments the company continues to make with its app, to improve the boarding process and pre-boarding spending opportunities (booking excursions, spa, and more) will allow customers to both have more time on the ship (rather than embarking and debarking) and more time to replenish their wallets before beginning their voyages, also potentially generating incremental on board spend. These seamless efforts should help Royal generate free cash flow of more than $6 billion (utilizing updated capital expenditure figures) over the next five years.