Royal Caribbean Stock May Be Sailing Toward Stormy Seas

Key Points

• After nearly doubling off its post-Liberation Day lows, Royal Caribbean stock has little margin for error.

• The shares are richly valued relative to the stock's history and the broader cruise line peer group, and comps are getting tough to beat.

• The recent rally by the shares and lofty multiples, coupled with a challenging macroeconomic environment, could conspire to keep a near-term lid on Royal Caribbean stock.

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Following a mid-2022 fleet redeployment, Royal Caribbean (NYSE: RCL) has been a juggernaut among cruise line stocks, surging more than sevenfold over the past three years and more than doubling for the fiscal year ending Aug. 21.

Undoubtedly, those are impressive data points, but the second-largest cruise operator by revenue could succumb to waning momentum over the near term as tough year-over-year comparisons and macroeconomic headwinds take hold.

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Royal Caribbean's positive attributes

"Don't fight the tape" is an old investing pearl of wisdom, meaning investors are better off riding trends than fighting them. The saying is relevant in discussing Royal Caribbean because the stock has had momentum on its side. Looked at differently, simply because the cruise giant could be a pullback candidate doesn't imply that the retrenchment -- if it materializes at all -- will be deep or that market participants should aggressively short the stock.

Those are risky bets to place because Royal Caribbean has plenty of favorable arrows in its quiver. On Wall Street, the company is widely regarded as one of the best executors in the cruise industry, and its loyalty program differs from hotel peers in that it encourages repeat visitation rather than the earning and burning of points.

Additionally, consumers consider Royal Caribbean one of the premium names in the cruise line space. The company's recently launched Coco Cay destination and the Royal Beach Club in Nassau, coming online later this year, could be additive to demand.

Fundamentals? Check. Analysts expect Royal Caribbean to notch earnings before interest, taxes, depreciation, and amortization (EBITDA), free cash flow, and revenue growth this year and in 2026, cementing the notion that this is a structurally sound operator. The company's recent earnings per share (EPS) trajectory is impressive, as the recently completed fiscal second quarter represented the 13th consecutive period in which sell-side EPS forecasts were topped.

Looking further out, Royal Caribbean's knack for topping EPS estimates could continue, but it won't be easy because analysts are calling for earnings growth in the current quarter and three subsequent periods. The higher the bar is set, the harder it could be to clear if the macroeconomic environment doesn't cooperate.

Why Royal Caribbean could face stormy seas

Royal Caribbean has easily outpaced the S&P 500 this year, but that may be a case of the market focusing more on longer-ranging fundamentals than the specter of pullbacks in consumer discretionary spending and personal leisure budgets.

As for the factors that could become anchors on Royal Caribbean's ascent, they're not hard to find. This is a heavily indebted company. At the end of the second quarter, its outstanding liabilities stood at $19 billion, compared to cash and cash equivalents of $735 million, indicating high sensitivity to interest rate changes. Heavily indebted firms are often levered to Federal Reserve policy because high rates elevate their financing costs, which can sap profits, while making it harder to procure new capital. The problem is the Federal Reserve isn't guaranteed to cut rates, particularly if inflation remains sticky.

In fairness to Royal Caribbean bulls, Fed Chairman Jerome Powell recently signaled that the central bank could consider more accommodative monetary policy. That doesn't necessarily mean Royal Caribbean stock will come up aces.

One of the primary reasons central banks lower rates is to support a slack economy or stave off more weakness. In other words, a Fed rate reduction could be interpreted as an acknowledgment that the economy isn't where it needs to be, which could invite concern about stocks sensitive to consumer spending trends. Royal Caribbean checks that box.

As it is, plenty of leisure and hospitality stocks have already been bitten by that bug. If consumer sentiment and spending weaken, it's difficult to imagine Royal Caribbean sailing through that scenario unscathed. There's evidence that belt-tightening is already at play with cruise customers. Deutsche Bank's (NYSE: DB) second-quarter cruise survey indicates that travelers in the 55 and up age group expect to spend 4% less on their next cruise.

Paying up for risk with Royal Caribbean stock

Another oft-used investing saying is that valuation alone isn't a reason to buy or sell a stock. There's no getting around the fact that the market is littered with expensive names that have continually surged. Nvidia (NASDAQ: NVDA), anyone?

On the other hand, Royal Caribbean's status as an expensive stock shouldn't be ignored. It trades at 17 times earnings, compared to 10x to 13x for its peer group, according to Jefferies. That may be one reason investors are focusing on other cruise names. They want a bargain, or the perception of one, and Royal Caribbean isn't it.

Investor interest in other cruise equities is relevant for another reason. Historically, market participants, even some pros, have shown reluctance to own all of the big three cruise stocks -- Carnival (NYSE: CCL), Norwegian Cruise Line Holdings (NYSE: NCLH), and Royal Caribbean -- at once. Throw in Viking Holdings (NYSE: VIK), which went public in May 2024, and there are more options for investors to evaluate, potentially making Royal Caribbean's elevated cost of admission look all the more unappealing.

At the end of the day, Royal Caribbean is a difficult name on which to be overtly bearish or call a clear "sell," but like its peers, it's beholden to consumer sentiment and macroeconomic data. That could be a sign that a better port of call will avail itself, opening the door for investors to get involved ahead of 2026 ship debuts and further out additions to the company's roster of land-based destinations.

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Todd Shriber has no position in any of the stocks mentioned. The Motley Fool recommends Carnival Corp. and Viking. The Motley Fool has a disclosure policy.