In this podcast, Motley Fool senior analyst Bill Mann discusses:
- The prospect for more acquisitions and deployment of capital.
- Optimism being suspended this earnings season.
- Why he's watching homebuilders, especially Lennar.
Travel spending is heating up! Could that mean a rebound for cruise stocks? Motley Fool contributors Lou Whiteman and Jamie Louko engage in a bull vs. bear debate over Royal Caribbean Cruises.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on July 13, 2022.
Chris Hill: The headlines scream record inflation, but investors are handling it in stride. Motley Fool Money starts now.
I'm Chris Hill and joining me in studio. Because for the first time in 28 months we are in the studio. It's Motley Fool Senior Analyst Bill Mann. It's so good to be here in studio with you my friend.
Bill Mann: It's the first time since March of 2020 that we've been here and the man behind the glass Dan Boyd is here as well.
Chris Hill: It's fabulous.
Bill Mann: It's so great to see you.
Chris Hill: You know what's not fabulous. The fact that inflation rose 9.1 percent in June. It was higher-than-expected. I got to be honest, my reaction when this came out because I knew the number was coming out this morning.
Bill Mann: Yeah. You bought groceries? [laughs]
Chris Hill: I bought groceries. I've filled up the car and spent an arm and a leg to do so. But my reaction Bill, honestly when it came out was OK but this is a backward looking number. This is for the month of June and we're in mid-July and we've already seen plenty of data around gas prices, around mortgage rates, and other places as well that says, Yes, this is bad, but prices have been coming down for a couple of weeks now, if not more.
Bill Mann: Now I'm going to make an economic argument here. I'm going to lose people, maybe you, maybe even myself. Let's strap ourselves in. There are two types of ways that inflation are measured primarily. There's CPI and then there's core CPI, consumer price inflation. Core CPI was 5.9 percent and they expected six for this recent release. The difference between the two is that core CPI eliminates food and energy. Whatever your consumer energy costs and whatever your consumer food costs are, those are the most volatile part of the curve and so they tried to ignore them to look at something more core. Now Chris, I know that like me, you can't get by without no food and no energy, so it's a little bit of a squarely number. It doesn't really exist, but it does show that, not that 5.9 percent inflation isn't really, really high, but it does give you a little bit more information as to what is actually happening.
Chris Hill: We're going get to earnings season in a couple of minutes. But before we do that, what if anything does this type of data do for you as an investor? Does it factor in for you at all or is it, I don't want to say background noise because that just dismisses it, but does it simply go in the category of, this is interesting, I want to know this data, but ultimately I'm focused on businesses and maybe I'll factor it in but in general, this isn't really swaying one way or the other whether or not I buy shares of a company.
Bill Mann: It does to some degree. If you think about it, let's make a very simplistic argument. Right now at a 9.1 percent inflation rate with the money that you are being paid by the company you work for, one-month's worth of it is evaporating to inflation. It's basically nine percent of every penny you make is disappearing. Yes, it matters. It matters a great deal. In some ways though, what we've seen not just the stock market, but almost every market is that almost all the asset classes have dropped. Not energy, maybe not the US dollar, but almost everything else. Which tells me that the reaction to this very real economic phenomenon that we're dealing with right now, people are reacting without a whole lot of forethought. They're just getting out. They're moving liquidity as quickly as they can. What you want to see right now and this is something that's actually it's healthy. It doesn't feel good, but it is in fact healthy. Companies that have cash-rich balance sheets, companies that have pricing power right now are in a position to go out and either increase their lead against competitors or they're able to buy up certain other companies, extend their brands, extend what service offerings they have on the cheap, which has not been available for a long long time. In some ways, what is happening and feel good, but it's entirely healthy and the strongest companies are going benefit mightily from it.
Chris Hill: With that in mind, when it comes to capital allocation, do you want to see companies you own shares of that meet that criteria, that are profitable, they've got the healthy balance sheet. Do you want to see them going out and making acquisitions or from a capital allocation standpoint, is your mindset more along the lines of what is your capital allocation superpower? What I mean by that is some companies are really good at consistently raising their dividend, some companies have a great track record of acquisitions. I'm wondering if your mindset is no, go the acquisition route, get rid of some competition, or is it no whatever you're good at in terms of capital allocation, I want to see you doing that.
Bill Mann: It's a little bit of both and it's a case-by-case basis. I mean, there are companies out there like Constellation Software, for example, which is a Canadian company that have a long fantastic track record of acquisitions. They've got to be walking around like kids in the candy store right now and they're acquiring companies for cash. To me when I see companies that are now starting to acquire companies, that's one of the key things I look for. Like what are they using? Are they using their own stock? Because as we've just talked about, everybody's share price is down, or are they using the cash that's in their balance sheet? I would much rather see them using their cash than using stock at this point to acquire companies. Ultimately, companies that go out and acquire, there are companies that are good at it, and there are companies that are not but they do give you a little bit of a signal by what they use.
Chris Hill: Earlier of this year, I want to say it was six months ago. I maybe off on that.
Bill Mann: That was in fact earlier this year. Well done. You did it. [laughs]
Chris Hill: That ends our math portion for the show. I would say to you that when NVIDIA came out earlier this year, with a great earnings report and good guidance. NVIDIA a big, profitable, important company. When they came out with that kind of report and shares of NVIDIA sold off eight percent that day, that was the moment for me personally when I thought, Oh, OK. Everyone on Wall Street has decided that no matter what a company has done in the past, no matter what earnings and guidance they come out with, nothing is going to be good enough and we are in for some pain. With that as a foundation, what is your mindset for this earning season? You and I have talked about this. I've certainly seen people on CNBC talking about this, expectations are across the board pretty low for this earnings season. No one's really expecting anyone to do anything all that impressive. What are you expecting?
Bill Mann: I think we are entirely as a market, we are in a suspending optimism phase where there really is nothing. You say something optimistic as a company and the market's initial reaction is, well, that's not going to happen. I don't know if you see what else is going out there. But one of the things that I'm really specifically looking for, is for those companies that have retained big cash balances to give a little bit more of a guidance for what it is that they plan on doing. I can guarantee you that there are companies out there that are looking at this environment and they're looking at what they have and they're saying, we are now able to make some decisions that in the next year to five years will transform our business in a very positive way. I think you're going to see it in the SaaS segments. Some of the biggest companies even Microsoft and Salesforce. I think that you will see them getting very active in taking out companies at a much lower price point that may be much more valuable within the framework of these larger companies.
Chris Hill: You have to assume that some of those smaller companies are much more amenable [laughs] to those conversations.
Bill Mann: Just give me a bid. Yes. Bound to be. I laughed when you said it. It's not 100 percent funny, but it is in fact the case that at this point in time, these companies came out and I think this is fair. They came out in a period of time in which it was really easy for companies to continue to raise money as they are growing. That time has stopped. It's absolutely the case that raising additional capital is going to be very difficult for them and so they are in a new stage right now. What is it that we do so that we can continue to fulfill our mission given the fact that we do need additional capital. For these big cash-rich companies to come calling, that is something that they absolutely positively will be listening to.
Chris Hill: I asked Jason this on Monday, I asked Asit yesterday and let me ask you before I let you exit the studio. What is a company you're going to be paying particularly close attention to this earnings season and why?
Bill Mann: You know, to me it's the Homebuilders in particular because what we've seen is home pricing. Oh, you said company, I'm sorry.
Chris Hill: No.
Bill Mann: I said home builders, let's call it Lennar. Home building is an industry that has healed from a price-to-earnings basis. It looks very cheap because they have been earning supernormal profits on building for the past couple of years, definitely over the last year. You're starting to see inventory building up in a lot of urban areas in the country. Redfin the other day came out and said that 40 percent of its listings have in fact already cut prices and that impacts and competes with the new home builds. To me, that's really going to be a sign of just how much froth has been in the system and just how far we have until we've recovered.
Chris Hill: Was that the same report where Redfin said that in the month of June they had 15 percent cancellations on existing home sales?
Bill Mann: Yeah. They've had enormous number of cancellations which is a contract that's been entered into. They've had mortgage rate locks are down 50 percent for second home purchases. People are pulling back in a hurry and it will be really interesting to see how this is actually impacting the biggest homebuilders.
Chris Hill: Great seeing you. Thanks for being here.
Bill Mann: Fantastic to be here in the studio with you, Chris.
Chris Hill: If parts of the broader economy are stumbling, one thing is certain, travel spending is heating up. Is it possible this means a rebound for cruise stocks? Our latest Bull vs Bear debate is on Royal Caribbean Cruise Lines with more, here's Ricky Mulvey.
Ricky Mulvey: Welcome to Bear vs Bull. We find some analysts, pick a company, flip a coin, and then you get to decide who made the better argument. Today the company is Royal Caribbean, our analysts are Lou Whiteman, Jamie Louko. Good to see you, thanks for being on the program.
Lou Whiteman: Glad to be here.
Jamie Louko: Yeah, thank you, Ricky.
Ricky Mulvey: Let's just get it started with the bull case for Royal Caribbean Cruise Line, and with that, it's Lou Whiteman.
Lou Whiteman: Thanks, Ricky. First of all, I should say, I am really glad to be a foolish investor when making this call because near-term, next few months, next few quarters, I'm really not sure how things are going to go. Inflation is out there, there's recession fears, COVID is still out there, we have higher fuel costs. It could be ugly couple of months for this business. But for long-term investors, people who can look past the near-term, there's a lot to be bullish here, and let me tell you why. First of all, for cruising in general, there is massive pent-up demand. Bookings have come back, a AAA survey from earlier this year, 20 percent of people who have cruised before currently have a trip booked. That is up from pre-pandemic levels. Sixty-one percent of respondents who have never cruised would like to try it, and that's only fallen about one percent. The pandemic has not killed the desire to cruise. Royal Caribbeans' fleet of 62 ships operated about 68 percent of rooms filled in the first quarter, they expect that to go over 70 percent. People have come back. Cruising is still a popular thing to do. It's not dead far from it. That's the bull case for cruising. But why Royal Caribbean in particular? I'm glad you asked. First of all, Royal Caribbean is a top operator. One of its brands celebrity was named US News best cruise line for the money. Another brand Royal Caribbean International, they finished tied for second. Secondly, this is the best balance sheet in the industry. The company has been aggressively paying down the debt that it took on during the pandemic. Debt right now is just one times equity. That's compared to about 1.4 times at Norwegian and 2.2 times equity at Carnival. Royal Caribbean had $3.8 billion in liquidity cash on hand at the end of the last quarter. That's reassuring based on all the talk about at the beginning where the next few months could be ugly.
For all the gloom of the current environment, Royal Caribbean did say the cash flow turned positive in April, and as of May, it's still expected to be profitable in the second half of this year. We'll see soon when earnings come up whether or not that's changed but this is definitely a company moving in the right direction. But the biggest reason to be bullish right now is that Royal Caribbean's pre-pandemic effort to use technology to boost profitability, it appears to be working. Revenue per passenger was up by four percent in the first quarter compared to pre-pandemic, the first quarter of 2019. Management attributes that to its new pre-cruise planning system that incentivizes greater spending. Their customer deposit base hit $400 million over the course of the quarter. That is future revenue coming in. That's a sign that they are still bringing business through the door. With Royal Caribbean, you have best-in-class in terms of brand innovation, use of data, balance sheet. One more thing I should mention, there's already so much negative activity priced in here that the next few months, maybe we can get through it. The stock right now is trading at levels similar to March of 2020. That's when ships weren't even sailing and quite frankly, we didn't know if they'd ever sail again. For all of the uncertainty we have now, I'm pretty comfortable in saying the outlook today right now isn't as bad as the outlook in March 2020. Bottom-line is Royal Caribbean is a survivor in an industry that still enjoys robust demand. This is a stock that was at 135 per share prior to pandemic, trading below 40 today. On an enterprise value, yes adding in the debt, it's still down 30 percent pre-pandemic. I think Royal Caribbean is set up well to get back to the levels it once was as the recovery takes hold. If it does, it should pay off handsomely for investors.
Ricky Mulvey: Lou Whiteman, thank you for the bull side. In the bear corner, we have Jamie Louko. Jamie, take it away.
Jamie Louko: Yeah. Thank you, Ricky. I'm going to concede with Lou that I think potentially the second quarter could be a really good quarter for Royal Caribbean because like Lou said, there's a lot of pent-up travel demand and that's coming out in all shapes and sizes. Other travel companies like Airbnb are seeing a lot of success and I think that Royal Caribbean will also benefit. But as we look further out, more than just one or two quarters, I think the picture gets more worrisome. For one, we have the fear of a recession in the US. Now, whether or not you believe that we're currently already in a recession or not, what's clear is that there's a lot of fear about a recession coming. Now, what does that mean for consumers? Spending's going to decrease, especially on discretionary spending like cruises and especially when it comes to more luxury cruises or trips like Royal Caribbean offers. Therefore, Royal Caribbean will probably see a big slowdown in bookings in the coming quarters and the rest of the year. Even if consumers are dead set on going on cruises, maybe this year or next year in 2023, they're going to opt for cheaper tours, and instead of going to Royal Caribbean, they might go to cheaper competitors. Then if you add on inflation and rising prices on need-to-have goods, you get a pretty bad picture for Royal Caribbean over the coming years. With this uncertainty in the economy, the next year or two could be pretty underwhelming for Royal Caribbean and the company will likely disappoint. Now, this might be why Wall Street analysts are expecting only $8.87 billion in 2022 revenue. This is down both from 2019 where they had about 11 billion in revenue and 2018 where they had just 9.5 billion in revenue. In other words, revenue from 2017-2022 is expected to increase just 1.14 percent.
Then additionally, if the US economy does get worse and perhaps the country does fall into a recession, I wouldn't be surprised if Royal Caribbean's revenue comes in below these estimates. But hey, if their top-line growth doesn't scare you, maybe the rest of their financials will. In Q1 2022, their losses surpassed revenue. Q1 total revenue was about 1.06 billion and their Q1 net loss was about 1.17 billion. In other words, for every one dollar they made in revenue, Royal Caribbean lost $1.10. Additionally, their balance sheet is really ugly. They have about two billion dollars in cash and in short-term debt alone, they have over 2.5 billion and in long-term debt, they have almost 20 billion. That is an upside-down balance sheet if I've ever seen one and it calls for concern over the long term. This would be concerning even in a great environment, but even in this scarier environment, that's even more worrisome. If Royal Caribbean's activity and therefore its revenue slows, that means less money is going into pay off this debt which is especially concerning given Royal Caribbean doesn't even have enough cash to pay off its short-term debt right now. Additionally, Royal Caribbean has an operating cash flow of negative 529 million in Q1, so it's burning cash too. That could change but compared to most recent quarter's numbers, that is pretty scary. Here's what we have, a cash-burning company that is facing an uncertain and likely painful year or two with a balance sheet that has some major red flags. Yes, this company could have a nice second quarter, maybe even a third quarter due to pent-up travel and vacation demand, but if we look at the macroeconomic environment and we look further out than a quarter or two, the problems really start to pile up. As a long-term investor, I'm going to keep my distance because of these structural issues and I think a lot of other long-term investors will do the same.
Ricky Mulvey: Jamie Louko, with the bear side coming in hot. Lou Whiteman, thank you for the bull case. It's very important for you to go on Twitter at Motley Fool Money, decide who made the better argument because the winner is going to win this fabulous prize.
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Chris Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. Will see you tomorrow.