A 55% Capacity Increase Will Test Cruise Pricing Amid Risks

Key Takeaways

• Macroeconomic uncertainties could temper consumer spending on cruises, impacting Royal Caribbean's yield growth and revenue outlook.
  
• Capacity increase may cause overcapacity, pressuring pricing and potentially affecting revenue negatively.
  
• Strong demand, yield growth, and increased customer spending signal potential for continued revenue enhancement and stable net margins through engaged customer base and strategic expansions.

Catalysts

Operates as a cruise company worldwide.

• Concerns about macroeconomic uncertainties could temper consumer spending on luxury vacations such as cruises, potentially impacting Royal Caribbean's expected yield growth and, in turn, its revenue outlook.
  
• The anticipated increase in capacity by 5.5% in 2025 due to new ship introductions may not correspond with increased demand, leading to potential room overcapacity which could pressure pricing and thus affect revenue negatively.
  
• Growth in adjusted earnings per share of 28% as projected might not materialize if consumer sentiment around leisure travel moderates or dips due to economic pressures, affecting overall earnings growth.
  
• Continued investments in fleet and guest experiences require significant capital, and post-COVID balance sheet strengthening initiatives might limit available resources for shareholder returns, potentially impacting investor sentiment and share valuations.
  
• Potential risks in achieving cost discipline might affect net margins if unexpected costs arise from supply chain challenges or inflationary pressures, compromising the company’s ability to enhance profitability as projected.

Royal Caribbean Cruises Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Royal Caribbean Cruises compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Royal Caribbean Cruises's revenue will grow by 7.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 19.4% today to 24.8% in 3 years time.
• The bearish analysts expect earnings to reach $5.1 billion (and earnings per share of $18.8) by about May 2028, up from $3.2 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 16.1x on those 2028 earnings, down from 19.1x today. This future PE is lower than the current PE for the US Hospitality industry at 21.9x.
• Analysts expect the number of shares outstanding to grow by 5.52% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.2%, as per the Simply Wall St company report.

Royal Caribbean Cruises Future Earnings Per Share Growth

Risks

• Royal Caribbean saw strong first quarter financial results and record Wave season bookings, suggesting higher revenues and robust demand for its cruises.
  
• The company has a strong financial position with investment-grade balance sheet metrics, robust cash flow generation, and minimal near-term maturities, which may contribute to stable net margins.
  
• Royal Caribbean anticipates significant yield growth from the introduction of new ships and private destinations, likely benefiting overall revenue and margin performance.
  
• Loyal customers, who account for 40% of bookings, are spending 25% more per trip, which could boost earnings through increased onboard spending.
  
• Continued enhancements in their technology and loyalty programs are driving deeper customer engagement, potentially leading to sustained earnings growth.

Valuation

• The assumed bearish price target for Royal Caribbean Cruises is $203.47, which represents two standard deviations below the consensus price target of $265.43. This valuation is based on what can be assumed as the expectations of Royal Caribbean Cruises's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $330.0, and the most bearish reporting a price target of just $200.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $20.6 billion, earnings will come to $5.1 billion, and it would be trading on a PE ratio of 16.1x, assuming you use a discount rate of 8.2%.
• Given the current share price of $228.01, the bearish analyst price target of $203.47 is 12.1% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.