This year has been incredibly hard for many companies, but few, besides perhaps those in the airline industry, have been hit as hard as cruise ship operators. Amidst the COVID-19 pandemic, many of these firms have struggled. What once were cash cows now have to resort to taking on debt and/or issuing stock in order to survive. One of the firms most affected by this downturn has been Royal Caribbean Group (RCL), the provider of four different major cruiseline operations. Its latest move, an issuance of both equity and convertible notes, is yet another pain for investors to contend with. But given the state of the industry and the uncertainty that poses for the firm moving forward, it’s better safe than sorry. In all, despite rising leverage this year, Royal Caribbean could go on to be an attractive long-term play for the right kind of investor.
A look at new developments
On October 13th, news broke that Royal Caribbean had decided to issue both common shares of itself and new convertible notes. In all, the firm is issuing 8.333 million common units of itself at a price of $60 apiece. Before factoring in any costs associated with its issuance, the company is expected to receive proceeds from this maneuver of about $500 million. In addition, the business has given its underwriters the opportunity to buy 1.25 million additional shares in itself at the same $60 unit price. This works out to another $75 million if everything goes according to plan for a grand sum of $575 million.
In addition to the stock issuance, Royal Caribbean has entered into another financial transaction aimed at improving its financial flexibility. This is for the issuance of $500 million in convertible senior notes that will come due in 2023. When they mature, management has the right to settle the notes in cash, stock, or a mixture of the two. These notes carry a low annual interest rate of 2.875%. In addition, the underwriters have been provided a 13-day option to buy $75 million worth of notes, bringing the raise to $575 million before any costs or discounts. One positive about their conversion is that while shares of Royal Caribbean are trading for around $60 as of this writing, these notes will convert subject to a price of $82.50 per share, or 12.1212 for each $1,000 in principal. This represents a 37.5% premium over the $60 issuance price of its common stock.
Management has not provided much in the way of details for how it intends to allocate this capital. They did say that they want to pay off their 2.65% Senior Notes that come due this year. This works out to about $300 million. Compared to the convertible note issuance, annual interest expense will rise by $0.68 million if you look at the picture from the perspective of dollar-for-dollar. This is an immaterial difference as far as management and investors should be concerned. The rest of the capital raised, meanwhile, will probably stay as excess cash on Royal Caribbean’s books until the crisis is over.
This is not the first time Royal Caribbean has gone out and raised money this year. In May, for instance, the firm issued $3.32 billion worth of Senior Secured Notes. In June, it raised $2.15 billion between Senior Guaranteed Notes and Senior Convertible Notes. The latter of these securities amounted to about $1.15 billion and will convert at $72.11 per share. Management has stated their intention to pay these convertible notes off in cash when they mature in 2025, so for the purpose of analyzing dilutive impacts, we will ignore the possibility of the 15.95 million shares these could convert into. What will be factored in, though, are the 5.2 million shares management issued subsequent to the second quarter’s end that were used to acquire the 33.3% interest in Silversea Cruises that Royal Caribbean did not previously own. At today’s pricing, that works out to $312 million in all. Also, in August, management secured a commitment for $700 million through a credit facility as well.
One thing is for sure here: Royal Caribbean is using an abundance of caution in how it conducts its business. At the end of its 2019 fiscal year, it had cash and cash equivalents of $243.74 million. By the time the second quarter this year ended, this figure surged to $4.15 billion. Gross debt over this timeframe jumped from $11.04 billion to $18.83 billion, though net debt rose more modestly, climbing from $10.79 billion to $14.68 billion. With so much cash on hand already at quarter-end, it’s clear management is planning for an extended period of pain.
If it seems as though the firm might be overreacting by keeping such a large amount of cash on hand, consider how the business fared in its recent quarter. During the quarter, it booked revenue of just $175.61 million. This represents a decline of 93.7% compared to the $2.81 billion the firm reported the same quarter last year. Its net loss during this period was $1.64 billion compared to the gain of $472.83 million a year ago. For the first half of 2020, Royal Caribbean’s cash flow amounted to a negative $2.05 billion. This compares to a positive $2.20 billion seen in the first half of its 2019 fiscal year. In fact, in its most recent update on the matter, management stated that they expect to hemorrhage cash of between $250 million and $290 million each month until the world starts to return to normal a bit. Management has said that they are looking for ways to cut costs and that will doubtlessly come to pass. But until guidance is released that touches on that, putting a number on it would be purely speculative.
If, say, Royal Caribbean needs to have $1 billion in cash on hand in order to make sure creditors are happy with it, and if we take into consideration recent financing transactions, management should be able to report $4.54 billion to $4.70 billion in cash by the end of October. Without further financing actions, this suggests ample liquidity for between 12 months and nearly 15 months. This latest set of refinancing, at the worst, will dilute existing shareholders by about 7,2%, which is a pain but it’s a small price to pay compared to the pain that might hit if management were not to have done this and happened to need the cash several months from now. In the event that the pandemic does end sooner rather than later, management can just use their excess cash to pay debt down.
At some point in time, the cruiseline industry will return to normal or something like it. It could be next year. But it will likely be in 2022 or 2023. So long as Royal Caribbean can make it between now and then, the future for the business should be bright. This is even with debt likely to be higher then than it is now. To see why this is, we need only look at how the business performed in recent years. Back in 2017, net income for the firm totaled $1.63 billion. Operating cash flow, meanwhile, was $2.87 billion. By 2019, both of these metrics had improved nicely, with net income expanding to $1.91 billion and operating cash flow totaling $3.72 billion.
Some investors will rightly point out that the company must also fund its capital expenditures. Originally for 2020, this figure was slated to be $4.7 billion, eventually increased to about $5 billion. For 2021, it was slated to be $3.5 billion. Due to the COVID-19 pandemic, though, management was able to defer a great deal of this because it is associated with newbuilds and non-newbuild, discretionary spending. For 2020, capex should now be $600 million, while next year it will likely be $1.8 billion. Some return to normal, eventually, would still allow some nice cash flow to be used toward debt reduction. The company may need to slow down its growth plans to achieve this, but that’s better than the alternative.
Based on the data provided, it seems clear to me that Royal Caribbean is in a tough spot at the moment, but its situation is not as precarious as some investors might think. Yes, COVID-19 is still a very major problem for the company, but it’s important to keep in mind that the business has plenty of cash on hand for the moment and that it can probably weather through the worst of it. Investors should anticipate a great deal of volatility and it also would not be surprising if the business issues more equity and/or debt, but once things turn back to normal in a year or so, it should be in a nice position to reduce leverage.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.