Why Cruise Stocks Are Taking on Water Today

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What happened

Shares of Royal Caribbean Cruises (NYSE:RCL), Norwegian Cruise Line Holdings (NYSE:NCLH), and Carnival (NYSE:CCL) (NYSE:CUK) were each down about 5% on Monday morning after the cruise industry was the subject of a cautious write-up over the weekend.

So what

Cruise lines were hit hard in 2020 after the pandemic brought their businesses to a halt, but the stocks have been part of the so-called “reopening rally” this year as investors look forward to a return to normal as the vaccine rollout progresses.

A report over the weekend in Barron’s splashed some cold water on that optimism, warning that the cruise operators have cut into future investor returns due to the $40 billion in debt and equity the industry raised during the downturn. The cash was necessary to ride out the storm, but higher interest expenses and bloated share counts will cost investors down the line.

The Carnival Legend cruise ship outside of Sydney Harbour.

Image source: Carnival.

Carnival, for example, expects to spend $1.7 billion on interest expense this year, compared to $200 million in 2019. The company also now has 1.1 billion shares outstanding, up from about 700 million two years ago.

The U.S. Centers for Disease Control and Prevention has still not yet given the green light to resume cruises, and it is unclear whether older populations who once were an important demographic for the cruise industry will return quickly once the ships set sail again.

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The report quotes Truist Securities analyst Patrick Scholes as saying the market is assuming 2023 will be better for the industry than 2019, which he calls “questionable.” Scholes has a sell rating on Carnival shares and a hold on Norwegian and Royal Caribbean.

Now what

It’s difficult to imagine the cruise industry disappearing, and it’s hard to blame the companies for raising the cash they did in order to make sure they would still be afloat when demand returns. But just as with the airlines and other businesses benefiting from the reopening rally, there is a question of whether the surge has gone too far, too quickly.

It’s worth noting a lot of analysts are much more bullish about when cruising will resume, and the state of Florida is backing industry efforts to get the CDC cruise ban lifted. But truth is no one knows what demand will look like, or how long it will take for operations to normalize once the ships are sailing again.

The cruise lines will hit the open seas eventually, but at least some caution is merited for now.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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