3/8/24 WSJ piece : cruise industry stocks, debts taken on during pandemic .........................
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WSJ
HEARD ON THE STREET
March 8, 2024
Cruises Are More Popular Than Ever -- and Investors Are Late to the Party
This year’s ‘wave season’ will break revenue records for cruise lines, but investors are wary of massive debts the industry took on during the pandemic
By Spencer Jakab
Still looking for an amazing deal on a cruise?
Four years after Covid-19 shut the industry down, a brief golden age of uncrowded decks and deep discounts has come to an end. With ships sailing at capacity and prime cabins selling out quickly, grabbing an offer as the industry’s traditional “wave season” winds down this month might be wise.
Investors are in more luck than travelers: Even though the lowest prices are off the table, bargains remain available in the shares of cruise lines -- especially for those not put off by a bit of choppiness.
“Wave season” is the term for the window of time at the beginning of the year when the cruise industry offers its best rates. During 2023’s season, executives were all but shouting to Wall Street that they were seeing monster demand. Analysts were slow to take the hint: More than two-thirds of those covering industry giant Carnival, for example, rated its stock a “sell” or “hold” early last year. Its shares, along with Royal Caribbean and Norwegian Cruise Line Holdings, were the top three performers in the S&P 500 during the second quarter of 2023.
Since then, though, only Royal Caribbean has been able to keep rallying, coming close to erasing its pandemic losses. The other two are still down by more than half. Further gains look likely for all three as anecdotes trickle in about what is shaping up to be the industry’s best wave season ever.
“The wind is behind their sails -- pun intended,” says Michael Erstad, a senior analyst covering the consumer sector at research firm M Science.
Cruises have long been affordable compared with land-based alternatives. That is especially true during bad economic times due to the unique economics of cruise ships -- last minute deals abound because it makes no sense to leave cabins empty. Even today, though, cruises offer a lot of bang for the buck. The all-in cost of shore-based hotels, flights, restaurant meals and vacation rentals have all risen more.
“We are nowhere near our ceiling when it comes to the price environment” says Carnival Chief Executive Josh Weinstein.
And more of cruisers’ dollars are hitting the bottom line as operators have become leaner and smarter. For example, they have gotten better at selling onboard, high-margin goodies such as drinks packages and shore excursions typically responsible for more than a third of revenue -- often before the ship even leaves port. Royal Caribbean’s CEO, Jason Liberty, gushed to investors last month that his company had 40% more pre-cruise revenue booked in 2024 than in the same period of 2023.
Another way cruise lines boost sales while also cutting costs is directing ships to their own private ports or islands. Often located a short sail from Florida, ships burn less fuel and nearly every dollar spent on drinks or souvenirs is captured by the cruise line. With many older ships retired during the pandemic, their fleets are also more fuel-efficient.
The best way to compare today’s profitability with the carefree days before the pandemic is net yield -- money left over per available passenger cruise day after paying travel agents and other operating expenses. Royal Caribbean, which recently launched the world’s largest cruise ship, Icon of the Seas, says its net yield rose by nearly 18% in constant currency terms compared with 2019 during the fourth quarter.
Things should be even better this year as passengers cruise in record numbers. One sign of a tighter market is how early they are making reservations. For example, Royal Caribbean’s cruises were being booked 202 days in advance on a rolling 12 month basis in December, according to Erstad. That was 11% longer than in the same month before the pandemic. He says that, partly as a result, pricing began a sharp improvement during 2023’s wave season that has continued.
So what’s the catch? A big one: Cruise lines had to borrow heavily to stay afloat financially when their ships were idle or half-empty. Between 2019 and the end of fiscal year 2022, net debt on the three largest cruise lines’ balance sheets more than doubled to $63 billion. All carry junk credit ratings.
But as any sailor knows, exciting things happen when you release ballast. Carnival has a set of Wall Street-friendly financial targets dubbed SEA Change. The most interesting one, “E,” stands for a 50% bump in a company-specific measure of earnings before interest, tax, depreciation and amortization by 2026 compared with what the company had been expecting last June for all of 2023. Much of that would be available to pay debt because Weinstein says the company is only taking delivery of three new ships between now and 2027.
“That is a remarkably small order book for this corporation, and that’s a good thing.”
Carnival’s free cash flow was more than $2 billion last year. Analysts polled by FactSet see it more than doubling by 2027. If Carnival meets its goals and reaches investment grade in a few years then it can also refinance expensive loans more cheaply, though much depends on how quickly the Federal Reserve cuts interest rates.
The cruise line that has made the most progress on its balance sheet and that analysts single out for navigating the pandemic best is Royal Caribbean. Its debt has been upgraded twice by Moody’s in just the past year. Though it has fewer ships and less revenue, it has gone from a market value half as high as Carnival’s in 2018 to one-and-a-half times as high today.
Royal Caribbean has momentum and is the safe choice. Investors with strong sea legs should consider Carnival, the cheapest of the bunch on a debt-adjusted basis. All three large cruise lines still trade below their 10 year average prior to the pandemic as a multiple of forward Ebitda.
Write to Spencer Jakab at Spencer.Jakab@wsj.com
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