Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Valuation & Dividend Safety Analysis: Royal Caribbean Cruises

Royal Caribbean Cruises Ltd (NYSE:RCL) has been pummeled by the market downturn resulting from the coronavirus scare. The stock is down over 30% in the past month and roughly 40% year-to-date. Simultaneously, the valuation has gone down to ~8.6X based on earnings and yield has shot up to almost 4%. As Baron Rothschild famously said, “buy when there is blood on the streets”, which means pretty much going against the crowd and when the fear factor is very high. For income investors, it may be possible to get a company with leading market share and a low valuation and high dividend yield. But with that said, dividend safety is of concern since it was cut during the Great Recession and was not reinstated until 2012.

Most Expensive Cruises in the World

Q4 2019 hedge fund letters, conferences and more

Overview of Royal Caribbean

Royal Caribbean is a cruise company that was founded in 1968. It operates under the Royal Caribbean International, Celebrity Cruises, Azamara Club Cruises, and Silversea Cruises brands. These brands operate either globally or regionally depending on their focus. Currently, the company has approximately 61 ships with another 15 on order. In 2019, the company carried ~6.5 million passengers. The company is one of the few large players in the industry. Major competitors include Carnival Corporation (CCL) and Norwegian Cruise Line Holdings (NWL).

Selected Data for Royal Caribbean (NYSE)

Royal Caribbean

Source: Data from Seeking Alpha

Dividend and Safety

Royal Caribbean’s forward dividend is now $3.12 giving a forward dividend yield of about 4.0%. This is double the S&P 500’s average yield of ~2.0%, which seems to make it a good option for those seeking a high yield stock for income. The dividend has been raised for seven consecutive years making the stock a Dividend Challenger. But the full impact of the coronavirus is probably not known at this point but certainly it will affect the bottom line. Hence, one should take a closer look at dividend safety metrics.

From an earnings perspective the dividend is reasonably safe. The current payout ratio is roughly 33.3% based on the forward dividend and consensus 2020 earnings per share of $9.37. This is well below my threshold of 65% and suggests that the dividend is safe. The dividend has been growing a double-digit rate for the past several years although the growth rate is slowing. The low payout ratio means that the dividend can be maintained even if earnings take a hit from an economic slowdown.

However, the dividend is not as well covered by free cash flow due to high capital expenditures from investing in ships. In fiscal 2019, operating cash flow was $3,716M and capital expenditures were $3,025M giving free cash flow of $691M. The dividend required $603M giving a dividend-to-FCF ratio of ~87%. This is above my threshold of 70%. If free cash flow is too high the company will need to use cash on hand, credit line, or debt to pay the dividend. The main risk is that cruising slows down due to the coronavirus leading to a drop in operating income. This would push the cash flow dividend safety metric over 100%. If cash flow does not cover the dividend for too long, then the dividend could possibly be cut.

Debt has also trended up over the past decade. Short-term debt now stands at $2,587 and long-term debt is $8,282M. This is offset by only $244M in cash, equivalents, and marketable securities, which is not much. The leverage ratio is higher than desired at a little over 3X. Royal Caribbean can meet its obligations though, since interest coverage is about 5X.

The dividend safety metrics are not completely encouraging, despite the high yield. In my opinion one should be wary due to the lack of coverage from free cash flow and high leverage.

Royal Caribbean’s Competitive Advantages, Risks, and Moat

As one of the larger players in the cruising industry, one would think that Royal Caribbean would have a wide moat. But the industry is cyclical and there are numerous smaller players, which probably limits the moat. However, Royal Caribbean’s scale combined with high capital investment requirements probably gives a narrow moat. The main short-term risk for Royal Caribbean is the coronavirus impact. Over a longer-term the main risk is that economic slowdowns tend to be amplified due to the discretionary nature of cruising. In addition, there are about 89 new ships coming online in the next few years that could lead to overcapacity and lower prices.

Final Thoughts

Despite the high yield and the potential as an income stock or dividend growth stock, I am not a big fan of Royal Caribbean. The main issue for me is the poor dividend safety metric from the context of free cash flow.

Disclosure: None

By DividendPower
Dividend Power is a blogger on dividend growth stocks and personal finance. Some of his writings can be found on ValueWalk. He also works as a part-time freelance equity analyst with a leading newsletter on dividend stocks. Dividend Power also publishes analyses on Seeking Alpha. He is currently is in the top 10% out of over 7,100 financial bloggers as tracked by TipRanks (an independent analyst tracking site).

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
This is a FREE report from Insider Monkey. Credit Card is NOT required.