Wednesday, June 8, 2011

RCL Commentary

Shares of Royal Carribean fell 5.96% in the market today.  The significant sell-off today, and dip over the past few weeks is attributable to:

1) Oil – The 12 members of the Organization of the Petroleum Exporting Countries (OPEC) met today to discuss the volatility and issues surrounding crude oil.  The Saudis’ proposal to increase production by 1.5 million barrels per day (from current quota of 24.85 million barrels/day), which would aid the struggling world economy and meet a recent increase in demand, was met with steep opposition.  The Saudi Arabian Oil Minister said it was “one of our worst meetings ever” as 50% of the group voted against the plan.  Crude oil spiked over a dollar when news leaked that no compromise had been made.  Generally, RCL has been trading inverse to the price of oil.

2) Consumer – An industry-wide concern has been how the consumer will react on all matrixes in the current market climate.  Major indicators, notably rising unemployment and decreasing confidence confidence, have not been positive and the result has been a sell-off on top of general uncertainty.

However, RCL remains in a fundamentally solid position despite an underperforming stock price.  We are reticent to take aggressive action on RCL at this time and believe that the current drop does not reflect any change in their business/strategic initiatives going forward, given the following:

a) RCL remains significantly hedged against oil volatility and has proved their ability to mitigate (and profit from) commodity pressure.  The company is approximately 60% hedged in 2011, 55% in 2012, 35% in 2013 and 15% in 2014.  RCL remains hedged up to $120/barrel through the remainer of the year, and is protected from any higher prices through options.  Management noted that over the past 5 years, 20% of fuel consumption per guest has been reduced through a combination of cleaner technology and derivative strategies.

b) Concerns arose around the consumer potentially cancelling vacation plans in an effort to deal with rising cost prices (gas, food, etc.), as a few believe that leisurely activities will be the first to be cut from the budget.  According to RCL, historically, there have not been any material signs of inflation forcing a customer to change scheduled cruise plans.  In addition, cruises remain a relatively cheap alternative when compared to land based vacation options.

c) As specified in my original thesis, supply in the cruise industry is nearing an all time low, which will allow RCL and competitors to gain pricing traction and increase profitability on top of revenue growth.  RCL recently spoke that they have begun to see these effects take place, and from the beginning of 2Q to date, European pricing is up mid-single-digits, while Alaska and the Carribean have been over-performing (up high-single-digits). 

d) International growth continues to be promising.  RCL is slowly penetrating into Brazil, Australia, and China, and believes that the European market will eventually become comparable to the dominant US market (in 5-7 years).

RCL is a levered play on cruise-line fundamentals, an industry that has significant growth opportunity in the near-term but is being negatively viewed in the current economic environment.  We plan on holding the company despite the drop since inception, and further declines may be likely as the market continues its downward trajectory.  RCL management says that the company will perform in-line with the guidance provided at the beginning of 2011, a strong statement given geopolitical events that occurred in Libya and Japan and their respective impact on earnings.

Please contact me with any questions.


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