At one point in February 2020, a single cruise ship – the Diamond Princess – was responsible for more than half of the world’s confirmed cases of Covid-19 outside of China. The 3,700 passengers and crew endured a grim quarantine off Japan; seven died.
But Covid has not proven to be an existential threat to the industry. Bookings have increased to pre-pandemic levels. And earlier this month, after a complete overhaul and several deep cleans under her owner Carnival, the Diamond Princess set sail for the first time in more than two years, bound for her new homeport of San Diego before returning to full service in the September.
“Everyone you talk to on cruises these days says, ‘Gosh, it’s good to be home, it’s good to be back at sea,'” said Mike Alcock, a 72-year-old Northamptonshire pensioner. who has taken six cruises with his wife since the industry returned from the pandemic and has booked three more.
“You wouldn’t go to a hotel that’s so spotlessly clean,” said Alcock, who has so much confidence in the industry’s ability to recover from the pandemic that he just bought 500 more Carnival shares. “People are addicted to cruises. . . Of course it will bounce back.”
What could bring down many of the industry’s biggest companies is something else entirely: huge debt icebergs. As cruise ships were moored in docks during the pandemic, the companies that owned them turned to debt markets in a desperate attempt to stay afloat.
The three big public cruise lines — which collectively control four-fifths of the industry — have all more than doubled their gross debt over the past two years. As a result, even as customers are clamoring to get back on board, markets are eyeing the companies with caution.
This week, Carnival’s share price plunged 14 percent after Morgan Stanley downgraded the stock and predicted – in a bear case – that its shares could be worth nothing. “[Carnival’s] Leverage looks unsustainably high,” the analysts warned.
Both Carnival and Royal Caribbean are among the S&P 500’s five biggest losers over the past three months — one of the worst quarters for the index on record — after shedding about half of their stock value. Norwegian is the 13th worst performing stock over the same period.
“The fear in the market is that the boat sailed most of the post-Covid recovery before cruise lines were back in service,” said Chris Woronka, an analyst at Deutsche Bank. “Now we’re talking about a potential consumer slowdown if they’ve just restarted.”
Woronka added that the slow recovery in the cruise industry — partly due to tighter Covid-19 restrictions from the US Centers for Disease Control and Prevention than other tour operators — meant companies “never really addressed their balance sheet issues ‘, leaving them ‘at the mercy of an enormous burden of debt’.
Royal Caribbean faces $8 billion in debt — a third of the total — maturing over the next 18 months. Carnival and Norwegian are due $4.1 billion and $1.8 billion, respectively, over the same period.
In May, Carnival refinanced $1 billion in debt by issuing a seven-year unsecured bond with an expensive 10.5 percent coupon.
Royal Caribbean chief executive Jason Liberty told the FT that the high yield “scares some people,” adding that such high coupons “certainly weren’t what we were expecting or planning.”
He acknowledged that Royal Caribbean will likely need to refinance debt at a “higher coupon than expected,” but stressed that it doesn’t have to refinance all of the $8 billion in debt that is due immediately.
Royal Caribbean’s next challenge is a $650 million bond issue in 2012 that matures in November. While the bond is trading close to par, suggesting investors expect it to be redeemed comfortably, the refinancing could be expensive. Royal Caribbean’s longer-dated bonds are trading at yields in excess of 10 percent.
Ash Nadershahi, a high-yield portfolio manager at Three Bridge Capital, said, “You need to refinance at a higher yield. . . The entire cruise industry may see a price adjustment.”
But Liberty insisted that some of Royal Caribbean’s $8 billion in debt be convertible bonds that could be redeemed as shares.
For the other burdens weighing on their balance sheets, companies have been able to come up with workarounds.
Royal Caribbean and Norwegian insure fuel costs. For 2022, for example, Royal Caribbean is 56 percent hedged at below market hedged rates. Fuel typically accounts for just over 10 percent of Royal Caribbean’s cost base, but that proportion has risen since the Russian invasion of Ukraine. However, Carnival has no fuel hedge and is “much more exposed” to rising fuel prices, according to Deutsche Bank’s Woronka.
Royal Caribbean is also responding “quicker” to food cost inflation, according to Liberty. The company now sources its bacon from Mexico, for example, where prices are far lower than in the US. “We simply load our ships in Mexico. . . and we just become our own supply chain or carrier of bacon for our fleet.”
Despite fears of an economic slowdown or even a recession, companies remain optimistic.
“While not recession-proof, our business has consistently proven recession-resistant,” Arnold Donald, Carnival’s outgoing CEO, said on a conference call last week. Liberty said Royal Caribbean’s competitive pricing would help weather a recession. “We’re trading at a pretty substantial discount on shore holidays,” he pointed out.
The experience of the recession that followed the 2008-09 financial crisis showed that “people will do a lot not to give up their cruise vacations,” according to Stewart Chiron, an independent industry consultant.
“Cruisers are very loyal,” Chiron said. “They’re going to make sacrifices in other areas: They’re going to eat out less, they might get different cars, they’re going to change their spending habits.”
But investors are not convinced. “Investors have basically said that I don’t really care about a good year for the sector to recover,” said Alex Brignall, travel and leisure analyst at Redburn. “A recession will only make 2023 terrible.
“Restoring viability [for cruise lines] was terrible, the balance sheets are very stretched, they are an operationally heavily leveraged company and they have a lot of debt to repay or refinance. In a recession they would be miserable.”