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Morningstar | Royal Set to Achieve 20/20 Vision One Year Early Helped by Strong Demand; Shares Undervalued

Despite launching 2020 goals just one year ago that reached for double-digit earnings per share growth, narrow-moat Royal Caribbean is set to eclipse its target by almost a full year, setting its outlook for $9.75-$10.00 in EPS ahead of the $9.62 we had previously forecast. Most importantly, we believe the success of Royal’s initiatives, including Project Excalibur (technology), Royal Amplified, Celebrity Revolution, and the impending Project Invictus (upgrade programs), have all resonated well with the consumer base and have further engaged travelers, ultimately leading to a better booked position for 2019 at higher rates.

Royal had previously offered color on idiosyncratic revenue and cost factors that were likely to impact 2019, including higher drydock days from the inclusion of Silversea, the opening of Terminal A in Miami , and the launch of Perfect Day at CocoCay, now slated for May. In our opinion, these investments stand to benefit the brand equity over the long term and help Royal’s ROICs average a low-double-digit level over our forecast, ahead of our 9.6% cost of capital. Investments come at a cost, however, leading to an expected as reported net cruise cost ex-fuel increase of 8.25%-8.75%, with 650 basis point s stemming from the above factors.

Similarly, these efforts reap benefits, and as reported yields are slated to rise 6%-8%, with 350 basis points rising from the same items. We plan to raise both our prior 4% yield and 5% cost growth to more closely align to updated expectations and anticipate only a modest increase to our $130 fair value estimate, rendering shares undervalued (even after a mid-single-digit rise today). A larger increase is held back by the higher depreciation we expect Royal to incur with the faster factor on Silversea ships and the rapid depreciation of technology investments, which should remain in focus given the incremental gains in customer loyalty and operating efficiency that could stem from such efforts.

Earnings per share results for the fourth quarter were modestly better than the $1.49 we had forecast and the $1.45-$1.50 the firm had guided to earn. Net revenue yield growth of 5.5% was in line with our 5.6% projection, with both ticket and onboard generating mid-single-digit increases. Net cruise costs excluding fuel were modestly better than the 6% we had modeled, rising 5%, as the timing of expenses shifted. We struggled to find any shortcomings in Royal’s financial commentary, with the global consumer base noted as strong independent of geography, despite some volatility surrounding Brexit, recent press regarding Germany slowing (a key market for TUI), and the rising concern that the United States could be close to the top of an economic cycle. The four quarters ahead are still booking well (higher volumes and price) and detail that two of the last three weeks of Wave season have marked record booking weeks implies that Royal’s products continue to resonate with customers.

We suspect there is some natural lift set for 2020 profitability, as investments in terminal A, CocoCay, and Project Invictus roll off and begin to generate returns for Royal. However, this doesn’t alter our normalized outlook for revenue and cost growth over the next decade, which should average 2.5% and 2%, respectively, over a full economic cycle.