Royal Caribbean (RCL 1.11%) has dramatically improved its financial conditions amid a return to the seas. With the company able to satisfy pent-up desires for travel, the cruise stock appears positioned to turn profitable in the near term.
The question for investors is, where does this leave them? The stock has returned to levels near pandemic lows as the post-pandemic state of Royal Caribbean comes to light. Is this swoon a sign to buy the cruise line stock or stay away?
Why investors might consider Royal Caribbean
Whatever one thinks of Royal Caribbean, it deserves praise for surviving more than a year that it was not permitted to sail during the COVID-19 pandemic. Now, more than a year after the industry received government permission to return to the seas, it is on its way back. In terms of market share, Cruise Market Watch reported that Royal Caribbean holds a 21% market share, second only to Carnival.
Moreover, in the first quarter of 2021, it reported nearly $1.1 billion in revenue. And while its net loss came to about $1.2 billion, it claims almost $2 billion in cash. While that may seem like too little liquidity to keep the company solvent, analysts project a return to profitability by Q3, indicating it holds enough cash to weather its recovery.
Also, while the stock has fallen, the current price of $36 per share is closing in on its March 2020 lows. And unlike the last time the stock traded at this level, Royal Caribbean can now sail, a fact that makes it appear more appealing. Additionally, the price-to-sales ratio of 3.5 slightly exceeds historical levels. Still, with revenue projected to grow by 479% this year and 43% in 2023, that sales multiple should fall over time.
Reasons to avoid the stock
The problem for investors lies in the reasons stocks typically rise. Investors tend to earn higher returns when stocks thrive. While Royal Caribbean will probably survive its industry crisis, prospering is likely a much taller order.
The measures Royal Caribbean had to take to survive the pandemic -- namely, running up debt -- will probably strain its balance sheet for years to come. Total debt came to $22.5 billion as of the end of Q1. This is almost double the level at the end of 2019 when total debt stood at about $11.2 billion.
Debt is also several times higher than the Q1 total shareholders' equity of $4 billion, the company's value after subtracting liabilities from assets. This level of debt has led to questions of whether it is about to be plundered, as that liability tremendously strains the balance sheet and leaves the company with limited capital to invest in itself.
Moreover, consensus estimates for 2023 earnings come to $4.93 per share, or approximately $1.25 billion. The company would have to sustain this pace for several years simply to return the total debt to pre-pandemic levels. This will likely keep Royal Caribbean in survival mode for years, a factor that will probably leave the stock struggling.
Should you consider Royal Caribbean?
Considering its financial state, Royal Caribbean stock will likely not beat the indexes. Indeed, Royal Caribbean looks poised to return to profitability. However, the level of debt required for it to survive the pandemic has put tremendous strain on the balance sheet. Thus, most profit will likely have to go to debt service rather than reinvestments to grow earnings over time. Such conditions leave the stock with fewer catalysts that could take it higher.
