At one point in February 2020, a single cruise ship — the Diamond Princess — accounted for more than half of the world’s confirmed cases of Covid-19 outside 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 for the industry. Bookings have surged to pre-pandemic levels. And earlier this month, after a total refit and several deep cleans under its owner Carnival, the Diamond Princess took to the seas for the first time in more than two years, bound for its new home port of San Diego before it returns to full service in September.
“Everybody you speak to on cruises nowadays says: ‘Gee, it’s good to be back home, it’s good to be back on the seas again,’” said Mike Alcock, a 72-year-old retiree from Northamptonshire, who has taken six cruises alongside his wife since the industry returned from the pandemic and has three more booked.
“You wouldn’t go to a hotel that’s as spotlessly clean,” said Alcock, who has so much confidence in the industry’s ability to rebound from the pandemic, he just purchased 500 more Carnival shares. “People are addicted to cruises. . . Of course it’s going to bounce back.”
What could sink many of the industry’s biggest companies is something else entirely: huge icebergs of debt. As cruise ships were moored in docks during the pandemic, the companies that owned them turned to the debt markets in a desperate attempt to stay afloat.
The three major listed cruise companies—which between them control four-fifths of the industry—have all more than doubled their gross debt over the past two years. Consequently, the markets are viewing the companies with caution, even as customers clamour to get back on board.
This week Carnival’s share price plunged 14 per cent after Morgan Stanley downgraded the stock, predicting — in a bear case — that its shares could be worth nothing. “[Carnival’s] leverage looks unsustainably high,” its analysts warned.
Both Carnival and Royal Caribbean rank among the top five losers on the S&P 500 over the past three months — one of the worst quarters for the index on record — having lost around half of their share value. Norwegian is the 13th worst performing stock over the same period.
“The fear in the market is that the boat had sailed on the best part of the post-Covid recovery before the cruise lines were back up and running,” said Chris Woronka, an analyst at Deutsche Bank. “Now we’re talking about a potential consumer slowdown when they just got restarted.”
Woronka added that the slow recovery in the cruise industry — due in part to more onerous Covid-19 restrictions from the US Centers for Disease Control and Prevention than are enforced on other travel operators — meant the companies “never really dealt with their balance sheet problems ”, leaving them “at the mercy of a tremendous amount of debt”.
Royal Caribbean faces $8bn of debt — a third of its total — maturing in the next 18 months. Carnival and Norwegian have $4.1bn and $1.8bn, respectively, coming due over the same period.
In May, Carnival refinanced $1bn of debt by issuing an unsecured seven-year bond with a pricey 10.5 per cent coupon.
Jason Liberty, Royal Caribbean’s chief executive, told the FT that the high yield “did spook some people”, adding that such high coupons were “certainly not what we were expecting or planning for”.
He acknowledged that Royal Caribbean was likely to have to refinance debt at “a higher level of a coupon than we had anticipated” but stressed that it would not have to refinance all $8bn of debt that is coming due imminently.
Royal Caribbean’s next challenge is a $650mn bond issued in 2012, which will come due in November. While the bond is trading close to face value, suggesting investors expect it to be repaid comfortably, it could be expensive to refinance. Royal Caribbean’s longer-dated debt is trading at yields in excess of 10 per cent.
Ash Nadershahi, a high-yield portfolio manager at Three Bridge Capital said: “They’ll have to refinance at a higher yield . . . the entire cruise industry will maybe have a repricing.”
But Liberty insisted some of Royal Caribbean’s $8bn of debts maturing before the end of 2023 could be paid down with the company’s “pretty healthy” $3.8bn in cash and revolving credit facilities and that at least $2bn worth of debt came in the form of convertible bonds, which could be paid out as shares.
For the other pressures weighing on their balance sheets, the companies have been able to come up with workarounds.
Royal Caribbean and Norwegian hedge on fuel costs. For 2022, for instance, Royal Caribbean is 56 per cent hedged at below-market rates. Fuel typically comprises just above 10 per cent of Royal Caribbean’s cost base, but that proportion has risen since Russia’s invasion of Ukraine. Carnival, however, does not have a fuel hedge, so is “much more exposed” to soaring fuel prices, according to Deutsche Bank’s Woronka.
Royal Caribbean is also being “more nimble” in response to inflation in food costs, according to Liberty. The company now sources its bacon from Mexico, for example, where prices are far lower than in the US. “We just load up our ships in Mexico. . . and we just become our own supply chain or transporter of bacon for our fleet.”
Despite fears of an economic slowdown or even a recession, the companies remain bullish.
“While not recession-proof, our business has proven to be recession-resilient time and again,” said Arnold Donald, Carnival’s outgoing CEO on an earnings call last week. Liberty said Royal Caribbean’s competitive pricing would help it weather a recession. “We trade at a pretty significant discount to land-based vacations,” he stressed.
The experience of the recession following the 2008-09 financial crisis showed that “people will do a lot to avoid giving up their cruise vacations”, according to Stewart Chiron, an independent industry consultant.
“Cruisers are very loyal,” said Chiron. “They’ll make sacrifices in other areas: they’ll eat out less, they may get different cars, they’ll change their spending patterns.”
But investors are unconvinced. “Investors have basically said I don’t really care about one good year in which the sector recovers,” said Alex Brignall, a travel and leisure analyst at Redburn. “A recession will just make 2023 terrible.
“The profitability recovery [for cruise lines] has been terrible, balance sheets are very stretched, they are very operationally leveraged companies and they have a lot of debt to repay or refinance. So in a recession, they would be abysmal.”