Royal Caribbean - Riding a Demographic Wave

GuruFocus.com

Sun, Apr 16, 2017, 8:44 PM

- By Dr. Paul Price

Get Onboard RCL- At a Nice Discount

The cruise ship industry is riding a demographic wave. Its prime consumer market is retirees who have both the time and the money to enjoy the thrill of unpacking just once, yet seeing multiple destinations. The baby boomer generation has barely begun contributing to demand. Increased demand from this group should make the industry's winning streak a long lasting one.

Warning! GuruFocus has detected 4 Warning Sign with RCL. Click here to check it out.
RCL 15-Year Financial Data
The intrinsic value of RCL
Peter Lynch Chart of RCL

Royal Caribbean (RCL) posted tremendous numbers over the past six years. The stock jumped nicely higher but still appears quite reasonably valued. That's true even with the overall market near record levels.

From 2010 through 2016, it is noteworthy that EPS rose much more dramatically than revenues. That is the very definition of profit margin expansion.

RCL's share price nearly tripled, and that figure does not include cash dividends, which were reinitiated during 2011.

Value Line's analyst believes the rate of improvement is poised to pick up even more over the next two to four years. So does management. They guided 2017 expectations to $6.90 to $7.10 per share, an all-time record number. Quarterly dividends increased 10.5% last fall. That marked the sixth straight year of higher cash distributions.

Can a stock that's almost tripled still be reasonably priced? Sure.

Since 2010, RCL's average P/E has been 15.5x. A typical yield has been 1.92%. As of April, 13, 2017, the stock's forward multiple was just 13.3x this year's consensus estimate. Royal Caribbean's current yield is a tad above normal, at 2.04%. That valuation is similar to what was in effect at many of RCL's previous best buying opportunities (green-starred below).

Obvious "should have sold" moments came with RCL trading for between 18x and 24x then current EPS.

A simple regression to a normalized valuation suggests Royal Caribbean could see $105 - $110 within a year. That's about 10% - 15% above its mid-April quote. That goal is far from an upper limit. The stock ventured north of $103 in 2015 when EPS were on pace to hit $4.82.

Independent research from Morningstar and Standard & Poors concurs. The former calls RCL's present day fair value as $105.

S&P's analyst, with RCL at $97.95, was more bullish than Morningstar. Standard & Poors rated RCL's fair value as $114, calling the stock one of the most undervalued names in their entire research universe (rated 5+ on a scale of 1- to 5+).

Option savvy traders can pocket excellent premiums by selling RCL Jan. 18, 2019, expiration date puts. Taking a long-term view (these options extend about 21-months) means standing ready to buy RCL at a set price at any time from trade inception right through expiration date.

There are lots of positives attached to these option sales. "If exercised" prices, on RCL's 2019, $85 and $90 strike prices, would be reduced to either $74.60 or $77.30 respectively.

Break-even points that low provide almost bear-market magnitude downside protection versus RCL's already-reasonable, trade inception price. If you liked Royal Caribbean in the $94 range you should really love it in the $70s.

By the time expiration date rolls around RCL is expected to be earning about $8 per share. Barring unexpected problems RCL's implied P/Es, if exercised, would be 9.3x or 9.7x. The exact nadir in 2011 was only time RCL was cheaper. The shares were about to sail from south of $19 to north of $103.

Maximum profit on these, or any other option sales, is keeping 100% of the money received up front. That would be either $1,040 or $1,270 per hundred-share contract in the examples shown.

Don't be put off by the fact that some traders are betting on negative price action. At the same time put buyers were betting on declines there were solid bids for RCL's 2019 out-of-the-money 2019 call options at $100 to $120 strikes.

Break-even prices for those call buyers runs from between $111.60 and $125.50. They can only win on upturns of 18% to 33% from RCL's April 13, 2017 close.

There are buyers and sellers for every option possibility so you shouldn't draw conclusions from their activities. Unlike option buyers, options writers know their best and worst case scenarios in advance.

If you'd be satisfied with the potential results it's hard to go wrong.

Royal Caribbean is a premier growth stock at a decidedly reasonable valuation. Buy the shares, sell some long-term puts or consider doing both.

Disclosure: Long RCL shares, short RCL options.

This article first appeared on GuruFocus.