Royal Caribbean: Cruising for Trouble
The cruise ship industry is taking on a lot of water. Last week, cruise ship operator Royal Caribbean Group (NYSE: RCL) reported negative revenue during the third quarter. Below, I’ll explain how their loss can be your gain.
But first, try to wrap your head around the idea that a business can have negative top-line revenue in the first place. It’s one thing for a company to report negative earnings for a quarter. That happens all the time.
But it is extremely rare for a business to have negative revenue. In this case, Royal Caribbean had to refund deposits for cruises that never happened due to the coronavirus pandemic that it had previously booked as income. So much so that the company reported $33.7 million in negative revenue for the quarter.
The analysts following the company were expecting revenue to come in at positive $12.4 million. That’s a huge miss. If they were really following the company closely then they should have known about the refunds.
Perhaps even more surprising, shares of RCL increased by more than 1% the day that news was announced. I’m familiar with the concept of contrarian investing, but this takes it to a whole new level.
The company went on to say that it is burning through $250 million to $290 million in cash every month while operations are suspended. That works out to one billion dollars every three to four months.
At that rate, Royal Caribbean would exhaust its $3.7 billion of liquidity by the end of next year. Of course, it intends to resume operations well before then, but I’m not so sure that is likely to happen.
Also last week, Dr. Anthony Fauci, Director of the National Institute of Allergy and Infectious Diseases, said: “I think it will be easily by the end of 2021, and perhaps even into the next year, before we start having some semblances of normality.”
If Dr. Fauci turns out to be right, it means cruise ship operators could be in a lot of trouble. The problem isn’t one of demand. Already, Royal Caribbean has a long waiting list of customers eager to board the next ship to anywhere.
According to the company, “cumulative booked position for sailings in the second half of 2021 is within historical ranges.” Many of those bookings are for passengers that accepted a future cruise credit (FCC) for a trip they paid for but never took this year.
The problem would be one of supply. Until COVID-19 is fully contained, there may not be a port in the world willing to allow a cruise ship to debark passengers.
We may soon find out. According to Royal Caribbean, it has been granted permission from Singapore to sail out of its port this December. The company claims that it has identified 74 safety protocols that it will suggest to ensure passenger safety. As you would expect, most of the measures are centered on testing and sanitation.
I can’t help but wonder how many passengers will faithfully abide by recommendation #16, which states, “Cruise operators should require guests and crew to wear cloth face coverings/face masks in accordance with CDC recommendations.”
The whole point of going on a cruise is to get away from the humdrum of everyday life. Having to wear a face mask to meals and have your temperature checked every morning before you leave your room would be a major buzzkill for most passengers.
Apparently, a lot of people on Wall Street disagree with me. Since bottoming out below $20 on March 18, RCL is up more than 250%. I’m not sure why the company is perceived to be in considerably less peril now than it was then, but I smell a trading opportunity.
In this case, I think a put option on RCL that expires next summer would do the trick. Last week, while RCL was trading near $54, the put option that expires on June 18 at the $55 strike price could be bought for $14.
For this option to have intrinsic value, RCL would have to fall below $41 over the next eight months. My guess is by then, the company will have had to delay resuming most of its scheduled cruises into 2022.
If that happens, Royal Caribbean will have more than a liquidity problem. It would have a solvency problem, which may require the company to declare bankruptcy to stave off its creditors.
Royal Caribbean would have to first pay off its lenders, and its only significant collateral is its ships. Under this scenario, those ships may not be worth enough to satisfy the debt. At that point, the common stock could be close to worthless.
To be clear, I am not hoping for such a fate to befall any business. But in this case, I think the stock market is grossly underestimating the likelihood that it could happen.
Editor’s Note: Under the dicey investment conditions that our colleague Jim Pearce just described, it’s small wonder that gold prices have soared. During times of uncertainty, such as we face today, investors rely on gold as a hedge against unforeseen crises.
Financial instability is a danger for risk-on assets, but it’s manna for gold. When the market crashes, money flees to safe haven assets, chief among them the yellow metal.
Every portfolio should have exposure to gold, especially now. For details on our favorite gold play, click here.