Cruise Line shares are on a wave. Here’s How They Could Sink.

Unlike the US airline industry, cruise lines were pretty much alone and received no financial backing from the federal stimulus bills. Why? Although the companies operate out of Florida, they are domiciled offshore in tax havens and pay no material U.S. income tax.

The sale of debt and equity gives the three companies enough money to weather the crisis, but they have paid a price. They will lower investor returns due to higher interest charges and a sharp increase in the number of shares outstanding.

For example, Carnival’s net debt is expected to increase to approximately $ 23 billion by the end of its current fiscal year in November, from $ 11 billion at the end of 2019. The company’s projected interest expense of $ 1.7 billion this year is from $ 200 million in 2019, and shares outstanding are up to 1.1 billion from approximately 700 million.

Dividends and share buybacks have probably been off the table for a number of years as companies focus on debt reduction. Market leader Carnival, which has raised $ 23.6 billion since March 2020, calls for caution with regard to its stocks.

The bull case is that the cruise lines will benefit from a massive pent-up demand as more people are vaccinated and the economy opens up. Investors have been willing to shake off the losses – Carnival reported a loss of $ 2 billion for the first quarter last week – and look forward to a full recovery from their travels.

Shares of Carnival, Norwegian and Royal Caribbean have been up lately, along with other travel-related stocks.

“There is certainly a reopening and momentum trading underway here,” said Patrick Scholes, an analyst at Truist Securities. “The market is baking a full return to sailing sometime early next year, which is questionable, and that 2023 will not only be a normal year, but also a year better than 2019, which is also questionable.”

He has a Sell rating on Carnival’s shares and a Hold rating on the Norwegian and Royal Caribbean’s.

Carnival, at about $ 29, is trading for 17 times its projected earnings per share of $ 1.67 in 2023; Norwegian Raises $ 31 13 Times Estimated 2023 Earnings of $ 2.30 Per Share; and Royal Caribbean, at $ 90, is trading for 15 times its expected 2023 earnings of $ 5.99 per share.

These are optimistic earnings expectations that assume higher corporate earnings in 2023 than in 2019. Morgan Stanley analyst Jamie Rollo, who has under-consensus earnings forecasts for the sector for 2023, wrote on Friday that “we doubt the sector will be larger or more profitable than he. was pre-Covid. ”

There may not be meaningful free cash flow until 2023 or 2024 due to interest charges and still high capital expenditures, as the industry tries to refresh a fleet with an average age of more than 10 years.

There are certainly signs that vacationers like to travel further and return to the seas.

Carnival highlighted that trend in a first quarter update last week. Booking volumes accelerated in the first quarter and were about 90% higher than in the fourth quarter, reflecting “significant pent-up demand,” Carnival said. It added that pre-bookings for 2022 are ahead of a ‘very strong’ 2019.

In a conference call, Carnival CEO Arnold Donald said the company had enough liquidity to run without revenue well into next year. His financial priorities, once the journeys begin, include regaining an investment-grade bond rating and lowering interest charges.

Jason Liberty, Royal Caribbean’s Chief Financial Officer, said earlier this year that the company expected the resumption of travel to lead to “attractive returns and a strong balance sheet.”

Mark Kempa, CFO of Norwegian Cruise Line, said in the company’s fourth-quarter earnings release that it “remained focused on our long-term strategic priorities and creating a clear path to financial recovery.”

Investors are partially drawn to cruise lines, Truist’s Scholes says, because they are among the few groups of stocks in the travel industry that are still significantly below prepandemic levels.

For example, Carnival is 40% below the $ 50 price at the end of 2019.

Still, the three cruise line operators projected end-of-year enterprise values ​​(equity plus net debt) that are higher than they had reached at the end of 2019 due to higher debt and more shares outstanding.

Much to the industry’s frustration, the U.S. Centers for Disease Control and Prevention have not set a firm date for the resumption of voyages from U.S. ports, although the agency sent an email last week to Barron’s that it wanted a “resumption of US passenger operations, expressed by many major cruise ship operators and travelers, hopefully by mid-summer”.

Norwegian Cruise Line recently offered to sail on ships with fully vaccinated passengers and crew to break the freeze and resume US voyages in July.

Norwegian CEO, Frank Del Rio, told CNBC that “it is time to get back to cruising” and that fully vaccinated ships are among the safest locations anywhere.

Scholes says fully vaccinated ships may not be a long-term solution for the industry, given that a significant percentage of Americans pledge not to be vaccinated.

When asked about fully vaccinated ships, Carnival’s Donald last week said the company “should see how that evolves.”

“The most important thing is to minimize risk,” he said. “We cannot be asked – preferably not and hopefully not – to stand up for a zero-risk standard, because frankly, nowhere else in society is taken into account. We just love to be treated the same as the rest of the travel, entertainment and tourism industry. And so if we do, it will be fine. “

While the number of bookings is high, it’s unclear whether travelers – and especially the elderly, a major target audience – will want to go on cruises just as much as they were before the pandemic.

Investors do not seem to reflect those risks or the dilution of income from the funding flow in their enthusiasm for the cruise line stocks.

Write to Andrew Bary at [email protected]