Covid couldn’t sink the cruise lines – but they now face an iceberg of debt

At one point in February 2020, a single cruise ship – the Diamond Princess – accounted for more than half of the world’s confirmed Covid-19 cases outside of China. All 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 reached pre-pandemic levels. And earlier this month, after a total refit and several deep cleans under the direction of her owner Carnival, the Diamond Princess set sail for the first time in more than two years, bound for her new port of San Diego tether before resuming full service. in September.

“Everybody you talk to on cruises these days is like, ‘Well, it’s good to be back home, it’s good to be back on the seas,'” said Mike Alcock, a 72-year-old pensioner from Northamptonshire, who has taken six cruises alongside his wife since the industry returned from the pandemic and has three more booked.

“You’re not going to go to a hotel that spotlessly clean,” said Alcock, who is so confident in the industry’s ability to rebound from the pandemic that he just bought 500 more Carnival shares. “People are addicted to cruises. . . Of course, it will bounce back.

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What could sink many of the biggest companies in the industry is something else entirely: huge debt icebergs. As cruise ships were docked during the pandemic, the companies that owned them turned to the debt markets in a desperate bid to stay afloat.

The three largest publicly listed cruise lines – which alone control four-fifths of the industry – have all more than doubled their gross debt in the past two years. As a result, markets view businesses cautiously, even as customers clamor to get back on board.

This week, Carnival’s stock price plunged 14% after Morgan Stanley downgraded the stock, predicting – in a bearish case – that its shares could be worth nothing. “[Carnival’s] leverage looks unsustainable,” its analysts warned.

Carnival and Royal Caribbean rank among the top five losers in the S&P 500 over the past three months – one of the worst quarters on record for the index – having lost about half their stock value. Norwegian is the 13th worst performing stock over the same period.

“The fear in the market is that the boat has sailed the best part of the post-Covid recovery before the cruise lines are up and running again,” said Deutsche Bank analyst Chris Woronka. “Now we’re talking about a potential consumer slowdown as they just restarted.”

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Woronka added that the cruise industry’s slow recovery – in part because of the US Centers for Disease Control and Prevention’s more onerous Covid-19 restrictions than those applied to other tour operators – meant that companies “n never really solved their balance sheet problems”, leaving them “at the mercy of a colossal debt”.

Royal Caribbean faces $8 billion in debt – a third of its total – coming due within the next 18 months. Carnival and Norwegian have respectively $4.1 billion and $1.8 billion due over the same period.

In May, Carnival refinanced $1 billion in debt by issuing a seven-year unsecured bond with an expensive 10.5% coupon.

Quarantined passengers watch from their balconies on the Diamond Princess cruise ship docked in the Japanese port of Yokohama in February 2020
Quarantined passengers watch from their balconies the Diamond Princess cruise ship docked in the Japanese port of Yokohama in February 2020 © Charly Tiballeau/AFP via Getty Images

Jason Liberty, managing director of Royal Caribbean, told the FT that the high yield “scared off some people”, adding that such high coupons were “definitely not what we were expecting or planning”.

He acknowledged that Royal Caribbean would likely have to refinance the debt at “a higher coupon level than we had anticipated”, but stressed that he would not have to refinance the full $8 billion of debt at maturity. imminent.

Royal Caribbean’s next challenge is a $650 million bond issued in 2012, which will mature in November. While the bond is trading near face value, suggesting investors expect it to be repaid comfortably, refinancing it could be costly. Royal Caribbean’s longer-term debt trades at double-digit yields.

Ash Nadershahi, high yield portfolio manager at Three Bridge Capital, said: “They will have to refinance at a higher yield. . . the entire cruise industry may have repricing.

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But Liberty insisted that some of Royal Caribbean’s $8 billion in debt maturing before the end of 2023 could be repaid with the company’s “pretty healthy” $3.8 billion in cash and facilities. revolving credit and that at least $2 billion of debt was in the form of convertible bonds, which could be paid for in stock.

For other pressures on their balance sheets, companies have been able to find workarounds.

Royal Caribbean and Norwegian cover fuel costs. For 2022, for example, Royal Caribbean is 56% hedged at below-market rates. Fuel typically accounts for just over 10% of Royal Caribbean’s cost base, but that proportion has increased since Russia invaded Ukraine. Carnival, however, does not have fuel hedging, so it is “much more exposed” to spikes in fuel prices, according to Deutsche Bank’s Woronka.

Royal Caribbean is also “more nimble” in responding to food price inflation, according to Liberty. The company now sources its bacon from Mexico, for example, where prices are much lower than in the United States. “We just loaded our ships in Mexico. . . and we simply become our own supply chain or carrier of bacon for our fleet. »

The Norwegian Getaway cruise ship docked at the Port of Miami
The cruise ship Norwegian Getaway docked at the Port of Miami © Marco Bello/Reuters

Despite fears of an economic slowdown or even a recession, companies remain optimistic.

“While not recession-proof, our business has proven to be recession-proof time and time again,” Carnival’s outgoing CEO Arnold Donald said during an earnings call last week. . Liberty said Royal Caribbean’s competitive pricing would help it weather a recession. “We are trading at a fairly large discount compared to land holidays,” he pointed out.

The experience of the recession that followed the financial crisis of 2008-09 showed that “people will do a lot to avoid abandoning their cruise vacations”, according to Stewart Chiron, an independent industry consultant.

“Cruisers are very loyal,” Chiron said. “They will make sacrifices in other areas: they will eat less at restaurants, they may have different cars, they will change their spending habits.”

But investors are not convinced. “Investors have basically said I don’t really care about a good year in which the sector recovers,” said Alex Brignall, travel and leisure analyst at Redburn. “A recession will only make 2023 terrible.

“The turnaround in profitability [for cruise lines] has been terrible, the balance sheets are very stretched, they are operationally highly indebted companies and they have a lot of debt to repay or refinance. So in a recession they would be catastrophic.