Sail Away From Royal Caribbean Cruises Ltd. (RCL)

Royal Caribbean Cruises Ltd. (NYSE:RCL) is a $7.5 billion cruise ship operator based in the US.  It’s one of the largest in the world, and offers cruises to over 400 locations across seven continents. Earlier this year, the company experienced a stomach virus outbreak aboard one of its ships. For its troubles, Royal Caribbean has received plenty of bad press. Some say the negative publicity and impending lawsuits are why the company’s stock price is down by more than 12% since January. I think there may be more to the price weakness than some upset stomachs.

Royal Caribbean Cruises Ltd. (NYSE:RCL)

Will Royal Caribbean Stay Afloat?

One criticism I’ve heard about Royal Caribbean Cruises Ltd. (NYSE:RCL) is that it’s overvalued. Royal’s current P/E is over 165x–that looks high even when compared against the already lofty 98x average multiple of its peers. Yet, under closer scrutiny, Royal’s P/E may not be as bad as it seems. Royal has a large amount of non-cash charges on its income statement.   For example, in 2012 it had $730 million worth of depreciation, which was 40x its net income of $18 million. This is actually normal due to the nature of its business (big boats = big depreciation). In addition, Royal Caribbean Cruises Ltd. (NYSE:RCL) had another $385 million of non-cash charges under “Unusual Expenses,”  due to write downs of goodwill and trademarks. Adjusted for these non-cash charges, Royal’s P/E falls to 6.4x (before taxes). The point is that Royal’s current P/E is less of a concern than it seems

I’d be more concerned about the company’s financial health. Over the past five years, Royal Caribbean Cruises Ltd. (NYSE:RCL)’s financial condition has deteriorated. Cash on its balance sheet declined from $400 million in 2008 to under $194 million in 2012. At the same time, current liabilities rose from $2.67 billion to over $4.06 billion. As of its most recent financial statements, Royal holds $216 million in cash and carries $5.06 billion in current liabilities. Even with receivables and “other current assets,” Royal Caribbean Cruises Ltd. (NYSE:RCL)’s current ratio comes in at a dangerously thin 0.16. Meanwhile, industry peers average 1.02 on the same measure. If this trend continues, Royal could have trouble staying afloat financially. The bottom line is that financial condition, not valuation or a stomach virus, is the real reason to be cautious about Royal Caribbean.

Dire Straits Getting Crowded

Royal Caribbean Cruises Ltd. (NYSE:RCL) isn’t alone–its main competitors seem to be in dire straits as well. Norwegian Cruise Line Holdings Ltd (NASDAQ:NCLH) is one such competitor. The company is a $6.34 billion cruise ship operator, trades at 71x earnings, and has the same financial problems as Royal.  Over the past five years, cash on the balance sheet fell from $185 million to $45 million. Meanwhile, current liabilities grew from $1 million to $945 million. Norwegian Cruise Line Holdings Ltd (NASDAQ:NCLH)’s current ratio comes in at 0.20. Like Royal, it may be one more virus outbreak away from a financial crisis.

If I had to favor one cruise ship operator, I’d pick Carnival Corporation (NYSE:CCL) – but only as the least bad of the crowd.  Carnival is the largest of the three and has a market cap of $26 billion. It has a current P/E of 17.8x.  It’s financial condition has actually been fairly consistent over the past five years. However, its current ratio still comes in weak at 0.30.  One somewhat redeeming item on Carnival Corporation (NYSE:CCL)’s balance sheet is its lower debt to equity ratio. At 0.40 it’s not great, but better than Royal’s and Norwegian’s, which are at 1.02 and 1.11, respectively.

Setting “Sale”

The rising debt and decreasing liquidity on Royal Caribbean Cruises Ltd. (NYSE:RCL)’s balance sheet are hallmarks of deteriorating financial condition and reason for concern. Since Royal’s closest competitors, Norwegian and Carnival, are also showing signs of duress, it may be that the cruise line business at large is facing headwinds. Be that as it may, among the three, Royal looks to be the deepest into troubled waters. While some may stay aboard and hope that Royal will turn the ship around, I think it’s time to set sail and hit the sell button.

Victor Lai has no position in any stocks mentioned. Victor Lai is an investment adviser representative with Bellwether Capital Management LLC, a registered investment adviser. Victor Lai does not own any positions in the securities referenced in this posting. Clients of Bellwether Capital Management LLC may own positions in the securities referenced in this post. This post is for informational purposes only and does not represent advice. You should conduct proper due diligence and/or consult with professional advisors before taking investment action.
The Motley Fool has no position in any of the stocks mentioned. Victor is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article Sail Away From Royal Caribbean originally appeared on and is written by Victor Lai.

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