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Due to its close proximity, purchasing power, and affordable financing, Royal has managed to secure a cost advantage moat source. Royal's brand is more accessible to potential customers as it ports popular ships in more places outside of the conventional Florida market, which should pique the interest of prospective new cruisers. Royal can reach a larger percentage of the population by using its 14 North American port options, which include New York, Seattle, and the greater Los Angeles area. Royal can deliver the product at a lower cost than its smaller peer group thanks to the improved scale benefits that incremental passengers provide. Over time, Royal should remain comparatively larger than many other operators due to limited global shipbuilding capacity, which will allow costs to be spread over a larger base. Since lower relative interest rates compared to the peer set will be made possible by cheaper ship funding through ECAs, debt financing costs below the line will give Royal an additional cost advantage.

Significant entry barriers support a moat source at an effective scale. For instance, the cost of ship builds may become more prohibitive for new peers if they are unable to obtain affordable financing through export credit facilities. Export credit organizations assist local businesses (shipbuilders) in reducing the risk of selling goods and services overseas by providing loans, guarantees, and insurance. Lower interest rates are associated with decreased counterparty risk. For comparison, Royal pays well below current market rates4 percent or lessfor the majority of its ship financing.However, smaller operators frequently do not have access to such low-cost debt. Prior to Silversea's partnership with Royal Caribbean, the company sought to refinance existing debt and new ship builds through a private placement of its $550 million notes, which were priced at 7.25%. Crucially, during the pandemic, these financing partners were accommodating and stopped amortizing payments while the industry was closed. Additionally, there is limited global capacity for new hardware in addition to special financing related to shipbuilding, which makes it challenging for any new peer to ramp up quickly.According to Seatrade Cruise, Royal currently has six ships scheduled for delivery between 2025 and 2027 (excluding river boats), compared to just two for brands like Wide-Moat Disney. could encourage prospective new cruisers to express interest. With 14 North American port options (US plus Vancouver), Royal can reach a larger percentage of the population. For instance, as Royal looks to increase the home ports of its fleet, the combined populations of the greater Los Angeles area (roughly 13 million), New York (20 million), and Seattle (4 million) represent 37 million potential travelers, or more than 11% of the US population.

Intrinsic Valuation

Royal Caribbean's robust performance in the fourth quarter and optimistic outlook for 2025 have led it stocks's intrinsic value to $161.71 but even then the stock is materially overvalued. The company's strong onboard revenue and improved pricing helped it achieve an adjusted EPS of $1.63, $0.16 higher than the estimate. There is minimal risk of increasing revenues as the wave season begins with comparable load factors from year to year and higher pricing. Better cost control, with flat reported cost growth in 2025 as opposed to 2% increases before the print, is primarily responsible for the forward lift. Supported by new hardware, onboard and excursion opportunities, and expansion into emerging markets, long-term projections have not changed.Foreign exchange and possible fuel prices, however, have the ability to sabotage tailwinds. If expenses are kept under control, Royal Caribbean's EBITDA margins could increase to a high 30 percent rate. Over the three years that ended in 2019, the company produced average returns on invested capital of over 9%; however, it is anticipated that it will surpass this level over the next five years, producing ROICs of 18%.

Investment Downsides

The impact of COVID-19, the US Centers for Disease Control and Prevention's no-sail and conditional sailing orders, and the global geopolitical environment are just a few of the risks Royal Caribbean faces that could affect its enterprise value. When demand declines, the company can manage pricing by redeploying ships or sourcing customers from other areas. However, if fuel prices stay high for a long time, volatility in commodity prices, especially oil, may have an impact on profitability. Changes to the company's tax status under the US tax code are long-term issues that could have a significant impact on profitability. Furthermore, global changes in maritime rules could impact Royal Caribbean's business, especially in relation to environmental, social, and governance (ESG) issues. In the past, cruise operators implemented scrubber technology to comply with global rules, but this retrofitting came at a cost, and Royal Caribbean could face costly environmental compliance if global rules change again.

Portfolio Management

It is anticipated that the company's projected returns on invested capital, including goodwill, will surpass the weighted cost of capital estimate of 10%. Although the balance sheet is getting better, high operating leverage and revenue cyclicality may still have an impact. The company is expected to pay down or refinance about $1.6 billion of its $20.5 billion total debt load that is due in 2025. By the end of 2025, Royal's net debt/adjusted EBITDA multiple should be less than 3.The company has resumed investments to elevate its brands, primarily through the purchase of new ships and refurbishments of its existing fleet. It is also investing in experiences at Paradise Island, Chile, and Cozumel. The management team has returned capital to shareholders when optimal, suspending dividends early in the Covid-19 cycle and halting share repurchases. Recently, the company reinstated its dividend at $0.40 per quarter, raising it to $0.55.

This article first appeared on GuruFocus.