At some point in February 2020, one cruise ship – the Diamond Princess – accounted for more than half of the confirmed Covid-19 cases in the world outside of China. 3,700 passengers and crew endured harsh quarantine near Japan; seven died.
But Covid has proven not to pose an existential threat to the industry. Bookings have soared to pre-pandemic levels. Earlier this month, following a full refit and several deep cleans by its owner, Carnival, the Diamond Princess set sail for the first time in more than two years, heading to its new home port of San Diego before returning to full service in September.
“Everyone you talk to on cruise ships these days says: ‘Gee, it’s great to be home, it’s great to be at sea again,'” said Mike Alcock, a 72-year-old retiree from Northamptonshire , he has been on 6 cruises with his wife since the industry recovered from the pandemic, and has booked three more.
“You don’t go to a spotless hotel,” said Alcock, who is confident in the industry’s ability to recover from the pandemic, having just bought another 500 shares of Carnival stock. “People are addicted to cruise ships. . . of course it will bounce back.”
What may have sank many of the industry’s biggest companies is something else entirely: a massive debt iceberg. With cruise ships parked at docks during the pandemic, companies that own cruise ships have turned to debt markets in a desperate attempt to stay afloat.
The three major publicly traded cruise lines — which control four-fifths of the industry — have more than doubled their total debt over the past two years. As a result, the market is wary of these companies, even as customers clamor to rejoin.
Shares in Carnival plunged 14% this week after Morgan Stanley downgraded the stock and predicted that — in a bear market scenario — its shares could be worthless. “[Carnival’s] Leverage looks unsustainably high,” its analysts warned.
Both Carnival and Royal Caribbean were among the top five losers on the S&P 500 over the past three months — one of the worst quarters on record for the index — and their shares have lost about half their value. Norway was the 13th worst performing stock over the same period.
“The concern in the market is that the ship is sailing into the best part of a post-Covid recovery before cruises resume operations,” said Deutsche Bank analyst Chris Woronka. “Right now we’re talking about a potential slowdown in consumers at the start of the restart. .”
Woronka added that the cruise industry’s slow recovery — in part due to the more onerous Covid-19 restrictions imposed by the US Centers for Disease Control and Prevention than those imposed on other tour operators — means the companies “never really deal with them. balance sheet issues”, leaving them “at the mercy of massive debt”.
Royal Caribbean faces $8 billion in debt — a third of its total — due within the next 18 months. Carnival and Norwegian have $4.1 billion and $1.8 billion, respectively, due over the same period.
In May, Carnival refinanced $1 billion in debt by issuing unsecured seven-year bonds with coupons as high as 10.5 percent.
Royal Caribbean CEO Jason Liberty told the FT that high yields “really spooked some people”, adding that such high coupons “certainly weren’t what we expected or planned”.
He acknowledged that Royal Caribbean may have to refinance the debt “at a higher coupon rate than we expected,” but stressed that it didn’t have to refinance the entire $8 billion in debt that was coming due.
Royal Caribbean’s next challenge is a $650 million bond issued in 2012, due in November. While the bond is trading near face value, suggesting investors expect it to be easily repaid, refinancing could be expensive. Royal Caribbean’s longer-term debt yields more than 10%.
“They’re going to have to refinance at higher yields,” said Ash Nadershahi, a high-yield portfolio manager at Three Bridges Capital. . . the entire cruise industry could reprice.”
But Liberty insists that some of Royal Caribbean’s $8 billion in debt due by the end of 2023 can be repaid with the company’s “fairly healthy” $3.8 billion in cash and revolving credit lines, with at least $2 billion worth of debt Convertible bonds, which can be paid as shares.
Those companies have been able to figure out how to deal with other pressures affecting their balance sheets.
Royal Caribbean and Norway hedge fuel costs. For example, Royal Caribbean is hedging 56% below the market by 2022. Fuel typically makes up more than 10 percent of Royal Caribbean’s cost base, but that has risen since Russia invaded Ukraine. However, Deutsche Bank’s Woronka said Carnival had no fuel hedge and was therefore “more vulnerable” to a spike in fuel prices.
Royal Caribbean is also “more nimble” in responding to rising food costs, according to Liberty. For example, the company now sources bacon from Mexico, where prices are much lower than in the United States. “We just ship in Mexico . . . we just become our own supply chain or ship bacon for our fleet.”
Despite fears of an economic slowdown or even recession, the companies remain bullish.
“While not recession-proof, our business has proven to be recession-proof time and time again,” Arnold Donald, Carnival’s outgoing CEO, said on an earnings call last week. Liberty said Royal Caribbean’s competitive Pricing will help it through a recession. “Compared to land-based vacations, we are trading at a considerable discount,” he stressed.
Stewart Chiron, an independent industry consultant, said the experience of the recession following the 2008-09 financial crisis showed that “people do a lot to avoid giving up on cruise vacations”.
“Cruisers are very loyal,” Chiron said. “They’ll make sacrifices in other areas: they’ll eat out less, they’ll probably get a different car, they’ll change their spending patterns.”
But investors are not convinced. “Investors are basically saying I don’t really care about a good year for the industry to recover,” said Alex Brignall, a travel and leisure analyst at Redburn. “A recession will only make 2023 scary.
“Profitability returns [for cruise lines] It’s been bad, the balance sheets are very tight, they’re companies with very high operating leverage, and they have a lot of debt to pay down or refinance. So in a recession, they’re going to be terrible. “