Smooth Sailing for Royal Caribbean

02/16/2017 10:00 am EST

Focus: STOCKS

We are upgrading our rating on Royal Caribbean Cruises Ltd. (RCL) to "buy" with a target of $116 per share, asserts John Staszak of Argus Research.

Royal Caribbean is the number-two cruise line in a capital-intensive industry with few competitors and strong market opportunities, as many potential passengers have never taken a cruise vacation.

It operates Royal Caribbean International, Celebrity Cruises and Pullmantur, Azamara Cruises, and CDF Croisieres de France, which together call on approximately 490 destinations. The company operates 42 ships, and will introduce eight more by the end of 2018.

Going forward, we expect RCL to benefit from lower costs and increased international demand, as well as from its investment in new ships, which should help to boost net yields and margins.

On January 26, Royal Caribbean reported 4Q16 earnings of $1.23 per share, up from $0.94 a year earlier, a 31% increase. EPS topped the consensus estimate of $1.21 and management’ s guidance of $1.20. The positive earnings surprise reflected lower-than-expected net cruise costs and fuel expense.

For all of 2016, revenue rose 2.4% to $8.5 billion and earnings rose to $6.08 per share.
North American consumers are fueling demand for European and North American cruises (Alaska, Bermuda and the Caribbean).

We expect the company’s operating margin to benefit in 2017 from higher spending on food and beverages, as well as from high occupancy.

Based on management’s guidance, as well as RCL’s history of positive earnings surprises, we are raising our 2017 EPS estimate from $7.10 to $7.20. For 2018, we are setting an estimate of $7.96.

In June 2015, its first Quantum ship was transferred to China, where RCL is working to become the top cruise line. Management noted that Chinese customers generally sign up for the most expensive cruises and are willing to pay premium prices for tickets, gaming facilities, and retail shopping opportunities.

The shares are trading at 13.1-times our revised 2017 EPS estimate and at 11.9-times our 2018 estimate, compared to a five-year historical average of 14.9.

We believe that the current RCL share price inadequately reflects prospects for strong cruise demand amid constrained supply, and expect continued positive earnings surprises in the coming quarters.

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