The Cruise Crowd Is Back, Even if Investors Aren’t. Here’s Why It May Be Time to Take a Plunge.

A number of factors are behind the continued malaise. Carnival and its main peers,

Royal Caribbean Group

(RCL) and

Norwegian Cruise Line Holdings

(NCLH), face some headwinds stemming from surging inflation, including rising fuel costs and the pressure that higher prices could put on customers’ leisure spending. What’s more, some potential passengers refuse to get a Covid vaccination, precluding them from cruising in most cases, and profitability for a full year is at least a year away.

These challenges hardly support a classic bullish thesis, but there’s one big reason to believe that the sector’s shares could start to sizzle this summer: People love to cruise. “We’re seeing that the demand still exists for travel,” says Jamie Katz, a senior equity analyst at

Morningstar
,
who covers the industry.

With the summer season—which in normal times is when cruise companies generate most of their revenue and profits—fast approaching, this is a good time to take stock of the industry.

On the plus side, more cruise vessels are sailing out of U.S. ports and elsewhere as ship occupancy improves, helped by operator mandates for Covid vaccinations and testing before boarding.

Onboard cruise spending in restaurants, spas, and other venues this winter and spring has been good. Bookings for this summer and beyond have been picking up.

And ticket pricing is holding up fairly well versus prepandemic levels across various summer destinations, such as Alaska, Europe, and the Caribbean, according to Patrick Scholes, an analyst at

Truist

Securities. Based on Truist data, Alaska summer prices are down roughly 5%, Caribbean summer cruise prices are ahead by about 5%, and Europe is up 5% to 10%.

Still, Scholes is concerned that prices could fall if the operators do more discounting closer to departure dates, something he has been seeing this year. “Cumulative bookings, which will be reflected in occupancy levels for the spring and summer, are still materially off 2019 pre-Covid levels,” he says. But “given the pickup in bookings over the past month, occupancy levels for spring and summer should be better than the first quarter’s.”

Of the three major cruise companies based in the U.S., Carnival was the most recent to report earnings. During its quarter ended in February, passenger occupancy was 54%, down from 58% the previous quarter, due in large part to the Omicron variant’s impact, but in March it was nearing 70%.

For the entire industry, “in mid-March, we started to see a sizable uptick in bookings. Certainly, that’s a positive,” says Scholes, who nevertheless has a Sell rating on Carnival and Hold ratings on the other two.

Chris Woronka, who covers the industry for

Deutsche Bank
,
has Hold ratings on all three stocks, pointing to skepticism even among analysts who see upside. “It’s still a good recovery story, but investors are still a little bit wary,” he says. “What we see is that this summer might be kind of a peak, and next year is still very much to be determined.”

That “doesn’t mean stocks should go down,” Woronka adds. “It just means that the risk-reward is not appealing enough to warrant a Buy.”

Another factor to consider is that to survive the pandemic, these companies—Norwegian and Carnival, in particular—raised billions of dollars of capital via the debt markets and by issuing more stock. While none of the operators has added significant amounts of new capital in debt or share sales since last year, adding more equity dilutes, or reduces, the ownership proportion of existing holders, while putting more leverage on balance sheets reduces earnings because of higher interest payments.

Steven Wieczynski, an analyst at Stifel, says that some investors won’t buy these stocks until the companies either break even in terms of cash flow or become cash-flow positive, because they “don’t want to take the risk that there’s going to be another equity raise or additional debt.”

The companies aren’t expected to swing back to full-year profitability until 2023, but they are sailing in the right direction. Carnival, for example, said in a release on April 26 that it expects monthly adjusted earnings before interest, taxes, depreciation, and amortization, or Ebitda, to turn positive at the beginning of the summer season.

Wieczynski has a Buy on Carnival, Royal Caribbean, and Norwegian. “Bookings in the back half of this year and into ’23 have been incredibly strong, so the demand is there,” he says. “If these companies can just get all their ships back in the water, they should be set up pretty well.” That’s barring another big setback from Covid, of course.

Handicapping these stocks isn’t straightforward, given different customer bases and areas of strength.

Norwegian, the smallest of the three companies, skews more to higher-end and luxury customers than the other two. “Their competitive advantage is that they have about a third of their business from super-high-end, luxury cruises,” says Truist’s Scholes. But in raising capital during the pandemic, Norwegian boosted its total of shares outstanding. They hit about 390 million at the end of 2021, more than 81% above the 215 million two years earlier.

Norwegian didn’t respond to requests for comment, but the company said during its fourth-quarter earnings call in February that it had completed some transactions that lowered its annual interest expense and “may lower diluted shares outstanding.”

Carnival also has had to hike its number of shares outstanding considerably. In its fiscal first quarter this year, Carnival had around 1.1 billion shares, up by about 65% since November 2019. The company has said that its interest expense this year will be about $1.5 billion. That compares with about $200 million in fiscal 2019.

Carnival spokesman Roger Frizzell notes that the cruise line has refinanced more than $9 billion in debt, cutting future annual interest expense by $400 million, and that it has performed “extremely well during past inflationary periods.”

The company, whose longtime CEO, Arnold Donald, plans to step down in August, has made other smart moves. Those include retiring 22 ships from its fleet, while modernizing it with some newer vessels to make its operations more efficient, potentially boosting Ebitda margins to above prepandemic levels, says Morningstar’s Katz.

A potential concern, however, is that the company relies heavily on mass-market travelers. If that segment “gets creamed by inflation or a recession,” that would pressure Carnival, says Katz. The stock, at $17 and change recently, was trading well below the $25 that his firm views as fair value.

Since the pandemic started, Royal Caribbean has performed the best among the three cruise operators. Its shares have lost nearly 30% since late January 2020, besting Norwegian, which is down about 60%, and Carnival, which is off around 55%. At about $80 this past week, Royal Caribbean stock was in line with the fair-value price that Morningstar puts on it.

“There has been a premium around quality of the business,” says Katz, adding that the company is regarded as a “really pragmatic operator.”

Its longtime CEO, Richard Fain, stepped down in January and was succeeded by veteran Chief Financial Officer Jason Liberty. Fain remains chairman. He was strategic in upgrading the company’s fleet and spending heavily to develop Perfect Day at CocoCay, an island in the Bahamas that Royal Caribbean owns and that has been popular with customers.

The company’s enterprise value was recently around 10 times its 2023 estimated Ebitda, well below its five-year average of about 12 times, according to FactSet. Royal Caribbean declined to comment, citing its coming earnings release.

Notes Stifel’s Wieczynski: “You can’t ignore how little Royal diluted their shareholder base, relative to the other two” cruise operators. From the end of 2019 through Dec. 31 of last year, Royal Caribbean raised its shares outstanding to about 255 million, an increase of 21%, the smallest of the three cruise operators.

Ultimately, then, while the three big cruise operators all seem to have upside, Royal Caribbean’s relatively limited dilution could make it the ticket for cruise-stock investors at this stage of the recovery.

Write to Lawrence C. Strauss at [email protected]