Cruise Lines Can’t Duck Their Debt
As the cruise industry recovers, debt that buoyed business during the pandemic now could sink stocks
Cruise ships, it seems, are like ducks—elegant and effortless above the water, fighting like crazy to stay afloat beneath.
On the surface, the industry is finally steaming ahead after over a year at bay: The world has reopened, occupancy limits have relaxed and bookings are at or above prepandemic levels. Carnival Corp., CCL 12.44%▲ Royal Caribbean Group RCL 15.77%▲ and Norwegian Cruise Line Holdings NCLH 15.36%▲ are all eyeing a near-term return to profitability this year—a milestone they are hoping will reignite investor interest, with their shares down an average of over 45% over the past six months.
On Friday, Carnival said it was still on track to see profits in the current quarter on the basis of adjusted earnings before interest, taxes, depreciation and amortization, sending shares of the entire sector up an average of nearly 15% on the day.
But for an industry just regaining its sea legs, the unfortunate reality is that it is sailing into a possible recession, with inflation and higher interest rates pinching an already cost-conscious consumer. Carnival, for example, also said Friday that cumulative advance bookings for the second half of the year are at lower prices compared with 2019 sailings, in part because of capacity increases—a change from higher prices on that basis as of March.
Tracking from multiple sell-side analysts shows weakening travel trends over the past few weeks, perhaps the first signs that economic pressures are beginning to damp what has been hyped as an especially strong summer travel season.
What is more, cruise companies are carrying boatloads of new debt taken out over the past two years to make ends meet. Despite a likely return to quarterly profits over the next few months, all major cruise lines’ debt-to-income ratios will soar to eye-popping levels in 2022 and are forecast to remain well above prepandemic levels even next year.
Earlier this month, a German shipping magazine reported that one of the world’s biggest cruise ships on order for Asia-based Dream Cruises could be scrapped before ever setting sail. Its parent company, Genting Hong Kong, ran out of cash earlier this year.
Such a scenario isn’t likely for U.S.-listed cruise lines which, thanks to significant pandemic fundraising, seem confident in their multibillion-dollar liquidity positions. But risks abound. Forecasts earlier this month from Truist’s Patrick Scholes show Carnival, which started the pandemic better-capitalized than peers, ending next year with a net debt to Ebitda ratio of around 4.6 times, versus 6.4 times for Norwegian and 5.5 times for Royal Caribbean. Spreads on Royal Caribbean’s credit-default swaps have more than doubled in six months, according to FactSet, even though occupancy was still significantly capped at the end of last year.
All that could be for good reason: As of the end of March, Royal Caribbean had roughly $8 billion in scheduled principal repayments through the end of next year, according to Truist—some 77% more than Carnival had at the time—despite Wall Street forecasting Royal Caribbean to earn over 30% less than its competitor on an adjusted Ebitda basis over the course of this year and next.
It isn’t all a result of the pandemic. Carnival, Royal Caribbean and Norwegian each have several ships on order for future delivery. Running hundreds of millions of dollars each, the majority of payment for these ships will come due upon delivery, according to UBS analyst Robin Farley. If only they could have waited for Genting to sink and taken that ship off the scrapyard.
The good news, according to Ms. Farley, is that, given early timing and the ability to leverage government subsidies from shipbuilding countries, U.S.-listed cruise companies were able to borrow significantly below current market rates to finance new ships. New builds will add capacity—helpful, assuming demand returns as hoped. They are also often faster, typically more fuel-efficient and can offer differentiating features such as roller coasters.
Based on each company’s latest quarterly report, Carnival had $7.5 billion in liquidity, including cash, short-term investments and borrowings available under the company’s revolving credit facility, to Royal Caribbean’s $3.8 billion, despite the fact that Carnival had fewer total ships on order as of last month.
Cruisers rarely venture below the waterline, but that is where investors should dwell.