Down 33% year to date, 2022 hasn't been easy for Royal Caribbean (RCL 0.74%). While the cruise company has rapidly bounced back from many of the worst impacts of the COVID-19 pandemic, high debt levels and macroeconomic headwinds are still major challenges. Let's explore some of the pros and cons of betting on the stock.
Better than Carnival Corporation?
Like with all cruise companies, the COVID-19 pandemic hit Royal Caribbean incredibly hard. But now, the company is enjoying massive growth amid easy comps and the relaxation of movement restrictions.
Third-quarter revenue jumped more than 500% to $2.99 billion amid a surge in passenger ticket sales and onboard customer spending on food and entertainment.
Royal Caribbean also swung back to profitability with an operating income of $298.4 million and a net income of $33 million. And according to management's recently released Trifecta Program, the company aims to surpass 2019's record earnings per share (EPS) of $9.54 by the end of 2025.
Within the cruise industry, Royal Caribbean looks better positioned than its rival Carnival Corporation, which generated a net loss of $770 million in its third quarter. While it is unclear why Royal Caribbean is outperforming its peer to such a large degree, it might have something to do with its focus on a higher-end side of the market that is more resistant to macroeconomic shocks.
The company still faces big challenges
While Royal Caribbean looks good compared to its peer, the company isn't out of the woods yet. While the worst of the COVID-19 pandemic may be over, it will take years to undo its damage.
As of the third quarter, Royal Caribbean reports $19.4 billion in long-term debt compared to just $1.6 billion in cash. Over the long term, this will be a huge drain on cash flow because it will have to be paid back and generate interest expense -- which totaled a jaw-dropping $352.2 million in the period (that is more than operating income).
With the Federal Reserve hiking interest rates, the outflow will increase, and it will become more expensive for companies to kick the can down the road by taking on new loans to refinance existing debt.
But rising rates are not the only major economic challenge. According to Bloomberg, some Federal Reserve staff believe the U.S. economy has a 50% chance of entering a recession next year. And an economic downturn could dramatically erode demand for luxury expenditures like Royal Caribbean's vacation cruises. The company may find itself in another crisis before it has fully recovered from the first one.
Is Royal Caribbean a buy?
For investors who believe in the future of the cruise industry, Royal Caribbean looks like the best of the bad bunch because of its swing to profitability and faster top-line recovery compared to its rival, Carnival Corporation. That said, with a high debt load in a rising-rate environment, the company faces significant downside risk. Investors may want to wait until some of these issues are resolved before buying shares.