Here we'll take a look at one of our favorite consumer cyclical stocks, Royal Caribbean Cruises (RCL) . Royal Caribbean has only paid a dividend since 2011, so it doesn't qualify for dividend increase streak groups like the Dividend Achievers. But investors would do well not to overlook this company just because it doesn't make such a list, as Royal Caribbean offers value, growth, and a nice yield to boot.
Navigating 50 Years of Growth
Royal Caribbean was founded in 1969 and since then it has expanded into six different brands. The company's fully-owned brands are: Royal Caribbean International, Celebrity Cruises, Azamara and Silversea Cruises. In addition, it is a joint venture owner of 50% of German brand TUI Cruises, and a 49 percent shareholder in the Spanish brand Pullmantur Cruceros. These brands count 63 ships in service in total, with an additional 13 ships on order.
Royal Caribbean is the second-largest cruise operator in the world, and services all seven continents with its diverse slate of vessels. The company should produce about $11 billion in revenue this year, and the stock trades with a $22 billion market capitalization.
Second-Quarter Forecast Offers Opportunity
Royal Caribbean reported second quarter earnings on last month and while results were once again strong, the company revised its guidance, and shares have traded lower since then.
Total revenue was up 20% in the second quarter against the same period last year. Gains were broad-based as passenger-ticket revenue increased 21%, while onboard spending revenue climbed 19% year-over-year.
The industry as a whole continues to see strong demand not only for tickets, but for spending on board ships, and Royal Caribbean is certainly no exception. It has performed well for several quarters in a row now on both metrics, with second quarter results seeing robust gains across the board.
Cruise operating expenses also rose 18% in the second quarter, and while that's a sizable increase in costs, it was under the rate of revenue growth. This expansion of revenue more quickly than costs leads to margin gains over time.
Cruise operating costs rose due to commissions, payroll, and food costs, among others expenses, as Royal Caribbean saw its operating expenses rise nearly congruently with revenue growth in the quarter. Interestingly, Royal Caribbean's fuel costs were up just 6% in the second quarter from the year-ago period. Cruise line operators have struggled mightily with fuel costs in recent quarters, but the second quarter was a welcomed respite from that headwind to earnings growth for Royal Caribbean.
With revenue growth outpacing expense growth, margins expanded, with operating income up 26% year-over-year in the second quarter. Earnings-per-share came in at $2.25, up from $2.19 in the year-ago period. Interest expense rose from $82 million to $111 million year-over-year, which consumed much of the operating income gain, leading to a more modest earnings-per-share growth rate in Q2.
The company guided for earnings to be in the $9.55 to $9.65 range on a per-share basis for 2019, which was a slight downward revision from prior guidance. Net revenue yields are expected to be up around 8%, including discontinued Cuba routes, while costs excluding fuel are expected to be up around 10%. As a result, we lowered our estimate for earnings-per-share this year after the second quarter report to $9.60 from our prior estimate of $9.75.
Looking Ahead for Investors
Royal Caribbean has seen outstanding earnings growth since the bottom in 2012. Indeed, should Royal Caribbean hit our estimate of $9.60 in earnings per share for this year, it will have achieved 28% annualized earnings-per-share growth since 2012. That's almost unbelievable, and we certainly don't expect that sort of growth to continue indefinitely. But we do see 8% annual earnings growth for Royal Caribbean in the coming years.
Fuel costs and currency exchange exposure are the company's two biggest risks as it relies so heavily upon fuel for its ships, and has no control over pricing. Royal Caribbean hedges just over half of its fuel costs, so some volatility is removed, but as we've seen from recent results, it is hardly a panacea. In addition, the global nature of its routes exposes it to revenue in several different currencies, and as has been the case of late, that leads to reductions in revenue and earnings once those revenues are translated into U.S. dollars.
But the company has 13 new ships coming into service by 2024, which will bring new capacity, as well as higher-margin revenue. New ships operate more efficiently than older ones, and consumers will pay more for new ships than they will older vessels. We also see no let up in the strong booking volume and pricing trends that have been in place for some time now, and Royal Caribbean looks poised to take full advantage of that.
We see robust annual returns in the coming years for Royal Caribbean as it offers investors a strong blend of value, growth, and yield. As mentioned, we see 8% annual earnings-per-share growth on the horizon, along with the current 2.7% dividend yield. However, the stock is currently trading for just 10.9-times 2019 earnings estimates, which compares favorably to our estimate of fair value at 14 times earnings.
We see around a 5% annual tailwind to total returns accruing from a rising valuation over time, at just 78% of fair value. Combined with the yield and expected growth, we see total annual returns in excess of 15% for new buyers of Royal Caribbean Thursday.
While investors certainly must take economic conditions into account when purchasing consumer cyclical stocks, the group has some members that offer investors outsized returns for those that can handle the risk. Royal Caribbean is one of those stocks and we see mid-teens total annual returns as very attractive, and we rate the stock a Buy as a result.