Royal Caribbean

Royal Caribbean plans to acquire a 50% equity interest in Sandals and Beaches Resorts for approximately $3 billion. The transaction has committed debt financing, is set to close at the beginning of 2027, and is expected to be accretive to 2027 EBITDA and earnings.

Why it matters: The tie-up's strategic purpose—to penetrate a larger part of the $2 trillion global vacation market—is sound. The all-inclusive exposure in Royal's portfolio allows it to target more than 50% of the US vacation market, more than double the current share of vacation wallet. The deal offers Royal a way to elevate the vacation experience, which should support rising returns on invested capital. The combination of ocean, river, all-inclusive, robust loyalty, and frictionless technology capabilities drive a positive flywheel for new and existing customer satisfaction. We don’t think Sandals will cannibalize cruise bookings, as there's only an 30% overlap between Royal and all-inclusive guests. We see this as a way for Royal to capture upside from an adjacent vacation segment that can also possibly provide destination options for cruisers.

The bottom line: We hold our $262 fair value estimate per share for narrow-moat Royal Caribbean and view shares as modestly undervalued (13% discount). Shares have fallen more than 30% over the last year as geopolitical volatility and travel costs have risen, placing overseas bookings at risk. The neutral valuation impact from the transaction stems from three offsetting factors in 2027. First, we deduct the $3 billion raised and paid for the tie-up. Second, we increase interest expense assuming the transaction is fully financed. Last, we add around $200 million in income from the venture. Royal paid a reasonable forward EBITDA multiple of approximately 10 times, which is in line with the multiple Hyatt paid for Playa in 2025. Even with the incremental debt, Royal should end 2027 with net debt/EBITDA below 3 times, retaining its investment-grade status.

We are raising our fair value estimate per share for Royal Caribbean to $262 from $255,stemming from time value (around $5) and recent outperformance ($3) but hurt by near-term consumer hesitancy ($2). A second-quarter net yield lift of 1.9% and net cruise cost increase of 6.8% supported adjusted EPS of $4.21 at Royal Caribbean, ahead of its $3.83-$3.93 guidance benefiting from close-in demand, controlled costs, and solid joint venture results. Despite ongoing discord with Iran, which has elevated fuel costs and led to some consumer hesitancy around Mediterranean bookings, Royal raised its full-year EPS outlook to $17.73 to $17.87 from $17.10-$17.50. Our updated forecast calls for 2026 net revenue yield growth of 2.65% (near our 2.6% prior forecast) and net cruise costs, excluding fuel of 0.4% (down 10 basis points from prior) leading to adjusted EPS of $17.75.

Our long-term estimates remain unchanged supported by new hardware, riveting onboard and excursion opportunities, and the expansion into nascent markets (Asia, luxury, river), driving modest price increases over time. However, tailwinds could be derailed by higher potential fuel prices and foreign exchange. We expect that pricing can grow 3% annually longer term, with capacity growth of 3% in the final five years of our outlook as Royal Caribbean optimizes its deployment strategy. In the longer term, we have both pricing and costs stabilizing at a low-single-digit growth rate. We anticipate Royal Caribbean's EBITDA margins can remain at a high-30% rate over our forecast if the firm continues to control costs.

Royal Caribbean had generated average returns on invested capital of more than 9% over the three years ended 2019; however, we believe the firm will handily surpass this level over the next five years, generating ROICs of 18%, in line with its Perfecta program goal.

We rate Royal Caribbean as having a narrow moat, which we believe arises from efficient scale and brand intangible assets. Prior to January 2024, we had a no moat rating on Royal, due to the uncertainty around the length of lockdowns and the impact to ROICs. We forecast ROICs that are even better than the pre-covid-19 period over our outlook, reaching nearly 26% at the end of our forecast versus 8% in 2019 (when the firm formerly held a narrow moat rating), well above our 10% weighted average cost of capital estimate.

To begin, we see efficient scale as a key moat source, which has often been reflected in highly capital-intensive industries. This is ascribed to the cost of ships (which can run north of $1 billion for new construction), increasing the capital requirements of operators, and the high fixed costs associated with the cruise model (we believe more than two thirds of costs are fixed in the short run).

Also, we see meaningful barriers to entry, which bolster the efficient scale moat source. For example, new peers may be unable to access cheap financing through export credit facilities, making the cost of ship builds less affordable. Export credit agencies offer loans, guarantees, and insurance to help local shipbuilders limit the risk of selling goods and services abroad, resulting in lower interest costs. For reference, Royal pays 4% or less on most of its ship financing, below current market rates. But often, smaller operators don’t always have access to such debt—before Silversea paired up with Royal Caribbean, the company pursued a private placement for its $550 million notes, which were priced at 7.25% to refinance existing debt and new ship builds. Furthermore, along with special financing around shipbuilding, there is limited global capacity for new hardware, making a fast ramp of a new peer difficult.

Additional evidence of efficient scale stems from sunk costs and historical precedent. As proof of the deep pockets essential to support passenger and capacity growth while remaining prominent in the industry, Royal had already devoted nearly $38 billion in net property, plant, and equipment (PP&E) as of June 30. Also, with respect to new entrants, Morningstar’s methodology indicates that if a market has seen little entry or exit over time, efficient scale is more likely to be present. Given that Royal’s share hasn’t shifted in recent years (at around 25% over the last decade), we believe the efficient scale moat source will remain in place over the next decade-plus, particularly given the fixed capacity of ship builders and the corresponding constraints.

We also think Royal has a brand intangible asset edge, as evidenced by pricing power, industry concentration, and risk aversion that dictates purchasing decisions. Pricing power has been displayed more reliably among the cruise majors in the last decade.

We attribute pricing growth to better revenue management systems, more dynamic pricing, and a stepped-up marketing strategy. But we also think Royal’s brands offer its passengers extremely unique opportunities through products like Perfect Day at Coco Cay. While Coco Cay, the private island owned by Royal Caribbean was a first mover in destination experiences, Carnival and Norwegian have followed suit with similar offerings. Fortunately, there is enough interest in cruising for all companies to benefit, given the limited capacity of cruise ships relative to the demand of the greater vacation market. We surmise over time Royal will continue to pursue destination development (including destinations in Mexico, Vanuatu, Santorini, and beyond) to continue to capitalize on additional itinerary excursion revenue.

Having such destinations on itineraries also protects pricing at Royal, as it allows the firm to pursue a strategic marketing plan, avoiding discounting. This strategy highlights the firm’s differentiated offerings rather than lowering prices to optimize occupancy, conveying to consumers that early booking is the best strategy to optimize price and room choice. Moreover, to prevent discounting during times of waning demand, the company utilizes bundling tactics to entice consumers, holding its pricing firm.

Also, considering the mix of repeat travelers in cruising and the aversion of travelers to trying a different brand with a dissimilar experience, we believe loyalty exists for passengers. For comparison, hotel operator chains get around 50%-65% of room nights booked by loyalty members on average, and we believe this level around 40% at Royal, which has led to supported market share. Plus, the increasing benefits that loyalty members obtain as they travel with their preferred brands aids in driving repeat business. For Royal Caribbean, after sailing just three nights with the brand, Crown & Anchor Society members get priority check in, exclusive rates, reduced rate upgrades, among other amenities, rewarding those that stick with the brand. We think this has surfaced in resilient market share over time, given finite building capacity and the high fixed costs.

We expect Royal will continue to drive higher pricing through its capital spending programs set to elevate the brands by uplifting the product while in dry dock, increasing consumer willingness to pay for sailing on that updated hardware, and bolstering spend around new onboard activities. Currently, Royal is investing in fleet modernization to improve consistency in the experience across the line, with plans to revamp Harmony, Ovation, and Liberty at the Royal brand in 2026). Generally, refurbished ships that have been put back into existing markets have performed well, garnering improved yields (pricing, often a mid-single-digit or more above existing hardware) versus pre-dry dock performance. We think Royal should be able to increase pricing by around 3% annually over the long term, near the roughly 2.4% inflation Morningstar expects between 2026-30.

If consumer preference for experiences over things persists, yields could rise faster than we currently expect as demand rises.

A reversion in fuel prices could help benefit the cost structure, as Royal Caribbean has partially floating energy prices (with only about 50% of fuel costs hedged historically).

As Royal reenters the China market, the nascent Asia-Pacific market provides upside. The four largest operators had capacity for nearly 4 million passengers prior to the pandemic, which offers opportunity for Royal to optimize deployment globally.

Weakness in consumer spending stemming from an economic downturn could affect discretionary spending and cause pricing to soften intermittently.

Volatility in input prices including commodity prices, energy, labor, and food, could cause profits to contract. Inflation across categories has become a more challenging headwind in recent years.

Health related concerns could return or new and unexpected regulations could pressure profits, leading to liquidity concerns if secular shifts in demand arises. Geopolitical risks could also dampen certain geographic opportunities.