Wachovia analyst: Royal Caribbean convertible attractive even with stock rise

By Ronda Fears

Nashville, Tenn., March 18 - Royal Caribbean's convertibles are still attractive and have some upside room despite the recent uptrend in the name, even without the Princess P&O merger but more so if that transaction goes ahead, said Sri Nadesan, convertible analyst with Wachovia Securities.

Improving fundamentals make the convertibles attractive even with the recovery in stock price and without the merger, the analyst said. Royal Caribbean has two 0% issues (Ba2/BB+), one due in February 2021 and another in May 2021.

"If the merger goes through, it will be an added benefit for these bonds because Princess is a better credit," Nadaesan said.

"If the merger doesn't go through, I don't think Royal Caribbean would revert back to previous levels, but there would be some short-term negative impact."

Royal Caribbean's merger offer with Princess, a friendly union proposal that was welcomed by Princess, hit a snag when rival Carnival Cruise Lines Ltd. rooted into the matter with its own merger bid. The parties are now in a standstill agreement, waiting on a position from regulators regarding the two merger proposals.

Since the merger turmoil erupted several weeks ago, Royal Caribbean's convertibles have richened from a yield-to-put of around 25% to the neighborhood of 10% or less, Nadesan said.

Both of the Royal Caribbean convertibles are trading at attractive terms and are cheap on an arbitrage basis, Nadesan said. The February 2021 issue is trading at a YTP (to February 2005) of 10.9% with a conversion premium of 39%. This bond is 12.6% cheap using a credit spread of 550 basis points, Nadesan said in a report Monday.

The May 2021 issue is trading at a YTP (to May 2004) of 6.6% with a conversion premium of 19%. This bond is 10.4% cheap using a credit spread of 550 basis points, the analyst said.

"The easy money has been made on these bonds but there's still some upside," chiefly due to improving underlying fundamentals, Nadaesan said.

Confirming the recent trends in cruise bookings, which reflect improved economic growth in fourth quarter 2001 and a more positive economic outlook for 2002, Royal Caribbean said first-quarter 2002 yields will likely decline 7%-8% rather than the prior guidance of a 15% loss. At the time the prior guidance was provided, Nadesan said he believed the company was being overly conservative and that yields were unlikely to decline more than 10% in the first quarter.

The company also said it expects to report earnings per share of 25c to 30c for first quarter. Previously, the company had not provided earnings guidance for the first quarter due to the difficulty of forecasting demand and pricing trends in the aftermath of Sept. 11.

"The improved operational outlook for 2002 should result in slightly improved debt statistics for Royal Caribbean," Nadaesan said in the report.

"Although debt will rise even with the better operational outlook, it clearly will not rise as much as the market had feared."

Nadesan estimates the company ended 2001 with $5.13 billion in long-term debt and EBITDA of $757 million. The improving environment could result in fiscal 2002 EBITDA of almost the same level as 2001, he said.

The analyst thinks Royal Caribbean's long-term debt could rise to $5.8 billion at the end of 2002 as it adds more ships. Assuming a flat EBITDA in 2002 compared with 2001, Royal Caribbean's long-term debt/EBITDA ratio at the end of 2002 is expected to worsen to 7.7 times from 6.8x. The interest coverage ratio will likely drop to 2.7x at year-end from 3.1x at year-end 2001.

"We expect the company's debt levels to rise in 2003, though we expect its credit profile to improve as rising revenue and EBITDA will likely improve the credit ratios," Nadaesan said in the report.

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