FactSet's Top Idea Tournament Winner: Short Royal Caribbean

The FactSet Top Idea Tournament is a quarterly research contest open to investment professionals at hedge funds, mutual funds, and private equity funds. Travis Cooke, the Founder and Managing Partner of Voss Capital, took home the most recent prize with his short thesis on Royal Caribbean Cruises Ltd RCL. "Royal Caribbean embodies many of the characteristics that I desire in a short investment: there is a cluster of insiders selling, there is no free cash flow generation, the business is destroying economic value due to low returns on capital, the shares are expensive on a relative and absolute basis, the industry is capital intensive and operates on price based competition, and the balance sheet is highly levered," Cooke wrote. "The cherry on top is they have poor earnings quality and use aggressive accounting." Cooke said that Royal Caribbean is emphasizing its Return On Invested Capital (ROIC) but is doing so at a time when industry supply growth is about to hit a positive inflection point. Cooke explained that a company must achieve an ROIC in excess of its Weighted Average Cost Of Capital (WACC) for growth to contribute to the value of the business and that growing a business that earns an ROIC below its WACC increases the rate of value destruction. The analyst noted that the Enterprise Value of a capital intensive business should trend towards book value of invested capital. However, shares of Royal Caribbean are trading at approximately 2.14x Book Value. "Getting the economics of the business in shape is more important than growth, but both the company and its investors are enamored with revenue and GAAP earnings per share growth, which have very little to do with value creation and there is a high likelihood when the slacktide ebbs – as it inevitably does – Royal Caribbean shares should sink back below book value ($37.78/share)," Cooke argued. Cooke has a Sell Short recommendation on Royal Caribbean with a $45 price target.