Consumers Continue to Demand Experiences, Buoying Royal's Booking and Pricing Prognosis

Senior Analyst

Jaime M Katz

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With travel constraints and coronavirus hesitancy in the rearview mirror, consumer behavior around travel and social distancing have maintained momentum at Royal Caribbean, leading to robust demand and pricing (ahead of 2019 levels) at the business. The redeployment of the fleet was completed mid-2022, and booking patterns have surpassed historical levels. As such, Royal Caribbean should see record pricing in 2023, with only mininal remaining bookings paid for with future cruise credits and still-elevated onboard spending. On the cost side, the impact of inflation and fuel prices could reman disruptive over the near term but have been managable over the course of 2023 thanks to hedging strategies, aiding profitability.

These factors should lead to average returns on invested capital, including goodwill, that are finally set to surpass our weighted average cost of capital estimate (10.5%) in 2023. While Royal Caribbean has carved out a compelling position in cruising thanks to its contemporary product, it still has to compete with other land-based vacations and discretionary spending for share of wallet, a key issue that underlies our no-moat rating. This could intermittently jeopardize top-line growth during transitory periods of land- and sea-based discounting.

The firm reduced operating expenses and capital expenditures as a result of COVID-19 (we forecast capital expenditures of $4 billion in 2023, partially to finance three ship deliveries). It also accessed significant liquidity, most recently raising $700 million in debt in February 2023 to replace debt coming due before the end of 2024. With $5 billion in customer deposits as of Sept. 30, and around $3 billion in debt maturities coming due through the end of 2024, there is still some refinancing risk on the table.

In November 2022, Royal unveiled its Trifecta initiative to capture capacity adjusted EBITDA of more than $100, double-digit adjusted EPS, and midteens ROICs by 2025. Despite global economic uncertainty, our forecast calls for $10.79 in adjusted EPS, capacity adjusted EBITDA approaching $100 in 2025, and midteens ROICs in 2026, as Royal's value proposition continues to resonate with consumers.

Business Strategy & Outlook

We lowered our economic moat rating for Royal Caribbean to none from narrow in spring 2020. While Royal Caribbean had historically benefited from its brand intangible asset, cost advantage, and efficient scale moat sources, we believe these factors were largely degraded, aggravated by the global spread of COVID-19 and its corresponding travel restrictions. Historically, Royal Caribbean touted a solid brand intangible asset, allowing it to capture solid yield growth, which averaged 4% in the five years ending 2019 and generated $209 per diem in 2019 (versus $179 for Carnival). For reference, we utilize 2019 metrics given the lack of comparability the 2020-22 fiscal years offers due to the pandemic. Fleetwise, Royal Caribbean (64 ships) still falls in the shadow of Carnival, which has around 90 ships. With pricing that has consistently proven favorable exiting the pandemic, we plan to watch performance through the difficult discretionary macroeconomic environment to ascertain whether the brand intangible asset can persist over a longer duration again.

Supply and demand equilibrium can often become dislocated, and as such, we expect Royal Caribbean could intermittently be a price-taker, despite offering its customers a compelling product with a value proposition. Given that pricing competitiveness could ensue as viral or geopolitical concerns surface, we don't expect pricing gains to be consistent. Specifically, we forecast yields that offer 2.5% average improvement over the long term, versus 4% average pricing increases in the five years ending 2019 (prepandemic). We see Royal Caribbean 

handily surpassing 2019 pricing in 2023 (it took until 2017 to recover back to 2008 yields after the last recession). While we think Royal Caribbean's go-forward strategy will package incremental benefits in its itineraries, and at times this will serve to boost onboard spending at the expense of ticket prices. 

Additionally, although there has historically been evidence that a cost advantage has persisted for the sizable operators (for example, over the five years ending 2019, Carnival, Royal Caribbean, and Norwegian all paid a high-20% level of net cruise costs on selling, general, and administrative expenses, while Lindblad, with eight owned expedition ships and five seasonal charter vessels spent more than 50%), we believe this argument may no longer hold true. Most importantly, scale could be lost from ships that require more significant dry dock efforts and others that have been scrapped or divested. Additionally, over the near term, there could be dislocation between revenue and items like payroll, food, and fuel, until Royal Caribbean has a more complete picture of how demand could ultimately trend longer term. We should be able to accurately reassess this quantitatively over the next few quarters with ship operators sailing at historical occupancy rates industrywide.

Our efficient scale moat source has also been disrupted as a result of COVID-19—a key tenet of which was barriers to entry. We had historically been concerned that large ships cost between $500 million and $1 billion, requiring access to liquidity. However, if some operators continue to trim older hardware from their fleet to rightsize the business (or liquidate, which occurred for Genting's Crystal and Dream brands), sold ships could be repurposed for another operator at a significantly lower price (although recently quite a few have gone to scrap). Furthermore, despite the high costs of entering the industry, some new players are still attempting to tap into the cruiser base as extensions of their existing operating businesses, like Virgin or Ritz-Carlton, potentially increasing the competitive landscape. 

Adjusted returns on invested capital, including goodwill, was nearing our estimated 10.5%

weighted average cost of capital between 2017-19. We believe Royal Caribbean could generate average ROICs of 15% over the next decade (with 13% forecast in 2023), north of our weighted average cost of capital.

None

Economic Moat

Royal Caribbean Cruises

Celebrity Cruises is a premium cruise line which was founded in 1988 by the Greece-based Chandris Group. In 1997, Celebrity Cruises Ltd. merged with Royal Caribbean International to become Royal Caribbean Cruises Ltd., which operates Celebrity, Royal Caribbean International, Azamara Club Cruises, Pullmantur Cruises and CDF Croisières de France.

Celebrity Cruises

Royal Caribbean Group is a cruise company, which engages in the ownership and operation of the following global cruise brands: Royal Caribbean International, Celebrity Cruises, and Silversea Cruises. The firm also holds interest in TUI Cruises GmbH, which operates the German brands TUI Cruises and Hapag-Lloyd Cruises. The company was founded by Arne Wilhelmsen in 1968 and is headquartered in Miami, FL.

Earnings data Q1 2024

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