Description

Company:                           Royal Caribbean Cruises, Ltd.

Security:                             7.5% $300MM Senior Notes ‘27

Price:                                   ~85c / 11.5% YTM 

Recommendation:           Long

Market Cap / TEV:           $13.4bn / $35.4bn

Executive Summary/Summary Thesis

At ~85c / ~11.5% YTM, the 7.5% Senior Notes ‘27 (“the Bonds”) present an attractive risk/reward to play the continued recovery for RCL and a transition back to investment grade status in the coming years while collecting ~9% current yield. Notwithstanding the Company’s strong liquidity profile, demonstrated access to capital and significant improvement in business fundamentals, particularly higher occupancy and accelerated booking trends, over the last nine months, the Bonds are trading back around 2020 levels owing to intensifying macro concerns and recent volatility in the corporate credit markets. Understandably RCL has raised significant secured/guaranteed debt in recent years to take delivery of new (and more efficient) ships and shore up liquidity ahead of the Bonds but there is still ~$13.5bn in subordinate equity cushion (~40% of TEV pre-conversion of the convertible notes), and the TEV is still below YE2019 levels.

While cruise operators are not for the faint of heart - capital-intensive businesses, cyclical in nature, hit hard by COVID and increased secured debt to manage liquidity - I am less bearish than the market (but also more conservative than mgmt.) and believe the Bonds will be paid par at maturity for the following reasons: 

1. Sustainable business model and steadily improving fundamentals
2. Strong liquidity
3. Undervalued creation multiple
4. Attractive position in the capital structure

The Company / Industry:

RCL and other cruise operators have been written up on VIC and it is worthwhile reviewing prior write-ups for background information. Briefly, RCL is a cruise line operator with a global fleet of 64 ships, +140k berths, three distinct brands (Royal Caribbean, Celebrity Cruises and Silversea Cruises) and a 50% joint venture interest in TUI Cruises GmbH which operates the German brands TUI Cruises and Hapag-Lloyd Cruises. In terms of exposure, ~61% of RCL’s revenue is for North American destinations (US, Canada, Mexico and the Caribbean) and ~80% of its passenger ticket revenue is originated from the US. The top three players (RCL together with Carnival (CCL) and Norwegian Cruise Lines (NCLH)) hold ~80% market share, generate net yields above $200 and EBITDA per capacity day margins in the 30-35% range. RCL has a market cap of $13.4bn and TEV of $35.4bn, is of similar size to CCL and about 2x the TEV of NCLH. Pre-pandemic, the Company generated ~$10.9bn in revenue and ~$3.4bn in Adj. EBITDA in 2019. COVID had a significant impact on the cruise industry and in 2021, RCL’s revenue and Adj. EBITDA fell to $1.5bn and negative $2.4bn, respectively. After a period of voluntary suspension during 2020 and 2021, the Company has steadily increased the number of ships that have returned to service with the full fleet in service as of June 2022. As such, performance has gradually rebounded in 9m22 with stronger results expected in 2023E and 2024E; my estimates for 2022E are ~$9bn for revenue and ~$750MM for Adj. EBITDA (see full operating model below for details).

Thesis:

(1) Sustainable business model and steadily improving fundamentals - Given the ~40% price gap to equivalent land-based vacations, there is significant pent-up demand for RCL’s cruise product as evidenced by the Company’s performance in Q3-22; revenue and earnings beat expectations, total revenue per passenger cruise day are now close to Q3-19 levels and bookings for future sailings were stronger than Q2-22 volumes and significantly higher than booking volumes in Q3-19. Importantly, 95% of total bookings in Q3-22 were new vs future cruise credits. As such, with +96% load factor in Q3-22, pricing at ‘record levels in historical context’ and the expectation that ~60% of 2023 bookings will be in place by YE2022, the Company is in good shape going into 2023 and is on track to meeting/surpassing its 2019 KPIs. The Company’s new Trifecta program lays out the roadmap to deliver strong results over the next three years: improve ROIC to teens (13%) from 10.5% in 2019, get to ~$5bn of EBITDA (from $3.4bn in 2019), generate +$10 EPS and return to an investment credit rating by 2025. My view is even if the Company falls short of its goals, the expected improvement in results compared to 2019, particularly transitioning from cash burn to cash generation, and the growing equity market cap cushion provide sufficient backstop for a refinancing/repayment event in 2027. 

(2) Strong liquidity – the company has liquidity of $3.1bn as of Q3-22, including $0.8bn in an undrawn RCF, $1.6bn in cash on balance sheet and $0.7bn commitment for a 364-day TL facility available to draw prior to August 2023. In addition, in Q3-22, RCL proactively termed out $5.6bn of 2022 and 2023 convertible, senior and secured note maturities to 2025 and beyond.  As such, ~$6.8bn of the Company’s $23.4bn gross debt stack is scheduled to mature prior to 2025 and almost all of that debt is secured, guaranteed or ECA-backed with annual interest in the L+1.50% to L+3.00% range and therefore readily refinanceable. From a cash flow perspective, Q3-22 was a seminal point where the Company generated positive operating cash flow (Adj. EBITDA less Cash Interest less Capex) for the first time in nearly three years.       

(3) Undervalued creation multiple - the Bonds are trading at ~5.4x ‘24E Adj. EBITDA, well below the 8-10x the cruise industry has historically traded for on an enterprise value basis (~8.7x my base case of ‘24E Adj. EBITDA). For reference my estimate of ‘24E Adj. EBITDA is ~18% above 2019 but ~200bps lower margins and more conservative than the Company’s Trifecta program.  

(4) Attractive position in the capital structure - the Bonds are sandwiched between the secureds and guaranteed debt that are yielding ~6.5% at 3.6x leverage on ‘24E Adj. EBITDA (or ~180bps/turn) and a ~$13.4bn equity market cap. For an incremental 2x in book leverage, the yield pickup is ~500bps (or ~250bps/turn). While the Bonds are trading at ~11.5% yield and offering equity-like returns, it is tough to believe they are the fulcrum given the significant improvement in fundamentals, strong liquidity profile, demonstrated access to capital and significant equity cushion.     

Risks:

(1) Transitory costs from COVID – in the post-pandemic world, there is clearly a risk that new variants could surface, cases could surge and the cruise industry could experience another period of mandated shutdowns. As such I expect costs associated with health protocols to remain elevated, albeit lower than in recent years.

(2) Inflationary pressures – RCL continues to navigate inflationary pressures, particularly food and fuel. While fuel consumption is ~50% hedged for 2023 and crude futures point to lower fuel costs in the future, if these inflation pressures to continue for a prolonged period and cannot be offset by higher prices, margins could remain below historical levels.

Catalysts: 

(1) Continued improvement in fundamentals / positive cash flow generation

(2) Continued access to capital / refinancing activity

Catalyst

(1) Continued improvement in fundamentals / positive cash flow generation

(2) Continued access to capital / refinancing activity