Updated on June 1st, 2022 by Josh Arnold
Cruise line operators tend to see immense earnings-per-share growth during times of strong economic growth and as a result, their stocks can do very well during such periods. Of course, the reverse is true, and cruise line stocks can become very risky during times of economic distress, or other external factors, such as 2020’s COVID-19 pandemic, the effects of which continue today.
During the steady economic growth of the past decade, certain cruise line stocks gained the ability to return cash to shareholders through rapid dividend growth, making the group of stocks potentially enticing for income investors as well.
Two of the three major cruise line operators–Royal Caribbean Cruise Lines (RCL) and Carnival Cruise Lines (CCL)–used to pay dividends to shareholders, but that all changed when the global pandemic halted the cruise industry as a whole. The episode highlighted just how vulnerable consumer discretionary stocks can be in extreme scenarios, and no cruise lines pay dividends to shareholders today.
In addition, with cruise lines still operating at reduced capacity, there is no time line for those dividend payments to return. Cruise lines are instead focused on conserving cash to avoid default on debt payments.
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The past two years have seen tremendous volatility in travel-related stocks. Valuations in travel-related stocks have come down significantly as of late, but so too have earnings estimates. The industry has been hampered by COVID-19 much longer than originally thought, and we are cautious on the group as a whole given the immense uncertainty.
In addition, the cruise lines are still expected to post losses this year based upon prevailing conditions, so don’t believe dividends will return anytime soon.
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In this article, we’ll take a look at the three major cruise line stocks and rank them according to their total return potential. Stocks are listed by five-year expected returns, in order of lowest to highest.
Cruise Line Stock #3 – Royal Caribbean Cruise Lines (RCL)
Royal Caribbean Cruises was founded in 1969 and since that time, has grown into five different brands that have 63 cruise ships in service. The company offers about 1,000 different destinations through its various routes for customers to enjoy.
Royal Caribbean is the second-largest cruise operator in the world and services six different continents. The company produced about $11 billion in annual revenue pre-COVID, and trades today with a market capitalization of $14.8 billion. Current projections put Royal Caribbean’s revenue above pre-COVID levels for 2023.
Royal Caribbean reported first quarter earnings on May 5th, 2022, and results were very weak, but showed that the company is on the path to recovery. Adjusted earnings-per-share came to a loss of $4.57, which was nine cents below estimates. Revenue was up from essentially nothing in last year’s Q1 to $1.06 billion, but missed by $90 million against expectations.
However, the company noted it continues to make progress on its long recovery from the COVID stoppage, and provided bullish commentary on the remainder of 2022 and beyond.
Source: Investor infographic
By the end of Q1, the company had returned 54 of its ships to operations across the five brands, which was about 90% of global capacity for Royal Caribbean. The first quarter saw about 800,000 guests travel with the company’s brands, and Q1 saw record total revenue per passenger cruise day. This is a key revenue metric that measures a cruise line’s ability to boost pricing for each guest, so this is quite positive.
Royal Caribbean’s operating cash flow was positive in April of 2022, marking a turning point for the company that has struggled since the COVID outbreak. Management expects to be fully operational across 100% of the fleet by the start of the summer season of 2022, which is another key milestone on the path to recovery.
Bookings in Q1 were higher than the fourth quarter of 2021, and improved every week sequentially during the quarter. In addition, compared to the same periods in 2019, which was pre-COVID, bookings were “significantly higher” across all periods. That speaks to the strength the company expects later this year and into 2023. Based on this, management said that it expects load factors to continue to improve each quarter this year until they exceed 100% by the end of 2022.
For 2023, all quarters are currently booked within historical ranges in terms of volumes, but at record pricing levels. This will not only drive revenue higher, but will help with margins as well, in addition to cash flow generation. Based upon these factors, Royal Caribbean expects to operate profitably in the second half of 2022.
Royal Caribbean continues to optimize its fleet, both by purchasing more efficient ships designed to burn less fuel, as well as encourage onboard spending, but also through divesting older ships. This effort will help it achieve its environmental protection goals, but has tangible benefits for shareholders as well. Higher revenue and margins will generate higher profits, as well as higher cash flow, all else equal.
We are forecasting 7% earnings-per-share growth for Royal Caribbean over the next five years, based off of earnings power of $8.00 per share. Fuel costs and currency exposure are common risks for cruise line operators and Royal Caribbean carries those risks.
Royal Caribbean hedges about 50% of its fuel costs so volatility will be lower from that factor, but currency swings can impact results positively or negatively at any given time depending upon where the US Dollar trades. Given that oil and fuel prices remain at or near record levels, Royal Caribbean’s earnings are somewhat exposed.
Royal Caribbean’s price-to-earnings ratio has fallen since the COVID outbreak, along with the rest of the industry. This has resulted in the stock being undervalued at present, providing what we believe is an opportunity for longer-term investors that can handle the inherent risk of owning a travel-related stock at this point.
The current price-to-earnings ratio of 7.3 compares favorably to our fair value estimate of 9 times earnings. That could produce a 4.4% tailwind to annual total returns over a five-year period, due to the rising valuation multiple.
We note our fair value estimates for the cruise lines is very low by historical standards, owed to the additional dilution and debt the operators took on to survive COVID. In addition, while the current outlook is strong, it carries with it significant uncertainty.
Overall, Royal Caribbean looks poised for 11.7% total returns, driven by the valuation tailwind and 7% earnings growth. There is no dividend, and we don’t expect to see one for some time to come.
Cruise Line Stock #2 – Norwegian Cruise Line Holdings (NCLH)
Norwegian Cruise Line Holdings was founded more than 50 years ago as an alternative to the more structured cruises that were offered on other carriers. The company’s “freestyle” cruising has resonated well with consumers and today, it operates 28 ships that generated almost $7 billion in annual revenue prior to COVID-19. Norwegian went public in 2013, and trades with a market capitalization of $6.8 billion.
Norwegian reported first quarter earnings on May 10th, 2022, and results were worse than expectations. However, the company noted it reached a “financial inflection point” during the quarter, meaning the company created positive operating cash flow during the quarter for the first time since the COVID outbreak. In addition, the company said pricing and volume for future bookings remains very high, so the company is quite optimistic on its future.
Norwegian lost $1.82 per share in Q1, which was 41 cents per share worse than expected. Revenue heavily missed the mark, coming to $522 million, which was $238 million lower than estimates. However, last year’s Q1 saw essentially no revenue, so the recovery is underway.
Source: Investor presentation, page 10
The slide above shows the recovery Norwegian has undertaken since the beginning of 2021, as management has been focused on survival. The good news for shareholders is that Norwegian sees positive adjusted EBITDA in Q2 of this year, and positive free cash flow in Q4. Further, management expects record occupancy and rates in 2023, which should produce record adjusted EBITDA for the year.
We see 12% earnings-per-share growth annually over the next five years off of our estimated earnings power of $2.00 per share. The company is building new capacity that is more focused on premium cabins, as well as more efficient operating, both of which should improve margins over pre-COVID levels. Fuel costs and currency translations are concerns for Norwegian but given the strong booking volume and pricing management is touting, we believe the earnings outlook is quite favorable, assuming Norwegian can operate at full capacity.
Norwegian trades for 8 times our earnings power estimate of $2 per share, and we assess fair value at 9 times earnings, driving a 2.4% potential valuation tailwind. As there is no dividend, the valuation and earnings growth combine to offer 14.7% estimated total returns annually.
Cruise Line Stock #1 – Carnival Cruise Lines (CCL)
Carnival Cruise Lines was founded in 1972 when it began as a small cruise ship operator. The company has been publicly traded since 1987, starting what was a long tradition of using shareholder capital to acquire other cruise lines. Today, it has 9 different brands that operate almost 90 ships, generating about $21 billion in annual revenue pre-COVID. The stock trades with a market capitalization of $15.6 billion today.
Carnival reported first quarter earnings on March 22nd, 2022, and results were worse than expected on both revenue and profits. Earnings came to a loss of $1.66 per share, 38 cents lower than expected, while revenue was $1.62 billion, missing estimates by $640 million. Like Norwegian, Carnival produced essentially no revenue in last year’s Q1.
The company said revenue per passenger cruise day was up 7.5% compared to 2019, and that 75% of the total capacity had resumed normal operations. Carnival expects positive adjusted EBITDA during the summer season, and a full-year loss this year despite a profit for Q3.
We estimate earnings power at $2.25 per share for Carnival, but expect 7% growth off of that level in the years to come. The company’s fleet optimization strategy is seeing a more efficient fleet that costs less for fuel, as well as optimizes onboard spending. Both of these help drive margins, and Carnival is seeing very robust demand for tickets both in terms of volume and pricing.
Carnival’s shares trade for just 6.2 times earnings power, against our fair value estimate of 9 times earnings. That could drive a 7.7% tailwind from the valuation in the years to come, and in conjunction with 7% projected earnings growth, we see 15.2% annual returns moving forward.
We note that Carnival has $29 billion in net debt as of the end of Q1, meaning it is extremely highly leveraged. Given that, Carnival carries with it more risk, as well as making it more challenging to eventually pay a dividend to shareholders. We believe Carnival is the furthest from having the financial capacity to return capital to shareholders, so that’s something for prospective buyers to keep in mind.
The extremely high projected rate of return for the three major cruise line stocks assumes a return to normalized operations over the long-term. Future returns are also based on their depressed valuation multiples, which could see upside if the coronavirus outbreak is contained sooner rather than later.
Of course, there is no guarantee that this will happen in the near-term. As a result, investors should expect continued volatility in the major cruise line stocks. These cruise line stocks could be strong investments based on their discounted valuations if they can return to growth, but investors will need to exercise patience.
We recommend investors hold a long-term view when considering cruise line stocks. Given all of these factors, we think Royal Caribbean is the best cruise line operator stock today for long-term income investors.
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