By Aaron Saunders
Cruise lines survived the global health pandemic by taking on more debt. Now, they face a new challenge of paying it all down.
In early October 2022, Carnival Corporation & plc reported its 10th consecutive quarterly net loss, sending its share price into freefall. When trading closed at the end of that day, its value per share was quoted at just $7.02 – a far cry from its high of $68 in January 2018.
The group, like every other cruise operator on the planet, was struggling with the fallout from the Covid-19 pandemic that had begun to sweep the globe in early 2020. Cruise lines that survived the pandemic did so by jettisoning old tonnage for fire-sale prices, laying off staff, and taking on immense debt loads to stay afloat.
By autumn 2022, cruising had largely restarted. Passengers flocked to ships in droves. Bookings rose to levels not typically seen in past years. Load factors were recovering quickly, and onboard revenue skyrocketed as passengers drank, ate, and explored their way across the seven seas.
The situation on the flip side of that coin, however, was dire, with interest rates rising, global exchange rates fluctuating, and fuel and provisioning costs increasing. Moreover, supply chain woes meant increased delays at shipyards, and there were problems securing everything from Heineken to hydraulics in a timely manner for ships still on the waters.
Carnival had taken on $35 billion in debt to stay afloat. By autumn 2022, along with every other cruise line, it found itself grappling with the problem of how to pay down its crushing debt load when, by all appearances, the business itself was going gangbusters.
Climbing debt mountain
In the equity market, both Carnival and Royal Caribbean Group were among the top five losers in the S&P 500 in summer 2022, as reported by the Financial Times. Both companies shed roughly half of their share value, with Morgan Stanley warning that Carnival’s share value could be wiped out completely. “[Carnival’s] leverage looks unsustainably high,” the firm’s analysts warned. The share price immediately shed another 14% on that remark alone.
By autumn, Carnival had borrowed another $2 billion from the junk bond market, putting up 12 of its cruise vessels across several brands as collateral. In total, the group’s offering netted a 10.75% yield to investors.
“Without the ships, I don’t believe that they would have access to capital at a price they would have been comfortable with,” said John McCain, high-yield portfolio manager at Brandywine Global Investment Management, in an interview with the Financial Times.
Access to capital is something cruise lines desperately need as they look to pay down debt – and even just to cope with the interest payments on that debt alone.
Should Carnival be unable to repay any of its debt, the 12 vessels it had issued as collateral could be arrested in port – something cruise passengers were blissfully unaware of. The names of the 12 vessels were not disclosed publicly.
Royal Caribbean, meanwhile, has some $8 billion in debt coming due in 2023, which will no doubt be pushed forward through the issuing of notes or something similar. The group has found efficiencies in its existing operational structure, such as sourcing bacon from Mexico, where it is less expensive than in the US, and raising onboard prices for everything from specialty restaurants to bestselling all-inclusive beverage packages, which can now run for over $100 per person per day on some sailings, potentially netting the company another $1,400 per couple on a weeklong cruise.
Analysts had cooled on Norwegian Cruise Line Holdings (NCLH) by the end of 2022. The company, which counts Norwegian Cruise Line, Oceania, and the upscale Regent Seven Seas among its brands, had weathered the debt storm better than its competitors, initially, but increased debt loads and fears of a recession drove its share price down too.
“We believe the risk/return is skewed less favourably now,” UBS analyst Robin Farley said in a note on NCLH’s performance. “While we believe the demand environment is improving, we do see some uncertainty in the outlook for NCLH’s cost performance.”
Farley was particularly concerned with projections that NCLH would have fourth-quarter 2022 expenses some 46% higher than in the same period in 2019, adding that it wasn’t immediately clear what was driving those projections. She noted that Q4 2019 also included the launch of a new ship, Norwegian Encore, so the rise in expenditures for the same quarter in 2022 was perplexing, when the line didn’t take delivery of the newbuild.
NCLH would end up laying off over 300 of its shore-side staff – around 9% of the total – in December 2022 as part of what the organisation called a “broad and ongoing effort to improve operating efficiencies”.
In early February 2023, NCLH followed Carnival’s lead by selling $539 million worth of notes with an 8.375% coupon rate, using 13 company-owned ships as collateral.
In some regards, analysts’ attitudes were more positive. “We don’t see any indicators or developments that cruise lines will not be able to obey their contractual repayment obligations,” said Carsten Wiebers, global head of aviation, mobility and transport at the Frankfurt-headquartered KfW IPEX-Bank. “Overall, the cruise business model – efficient cost baseline and competitiveness with other tourism sectors – is strong enough to enable the cruise lines to generate a substantial cash flow to reduce the leverage.”
The “R” word
Amid the debt, supply chain issues, rising interest rates, and other costs, there is another elephant in the room – and it’s a big one.
The mere hint of a recession, seemingly all the more likely in the US and Canada at present, is causing significant gnashing of teeth in the cruise industry – and for good reason. Even with record bookings and onboard spending, some cruise lines are just barely eking out tangible profitability.
Royal Caribbean, for example, plunged back into the red in the final three months of the last financial year. On 7 February 2023, it reported a net loss of some $500.2 million, or $1.96 per share, for the fourth quarter of 2022.
The news of the loss is all the more dramatic when one considers that, on a surface level, things are going very well indeed. The group reported load factors of 100% on its Caribbean sailings and 110% on its “Holiday 2022” sailings for the fourth quarter. Overall occupancy was 95%. Total revenues per passenger cruise day rose by 3.5% compared to the same quarter in 2019. This, by all measures, was the conclusion of a record-setting year.
And yet, even with full ships and increased onboard revenues, Royal Caribbean slipped back into the red after just one quarter (Q3) of thin net profit.
The company’s experience may not be unique and could set the trend for a bumpy 2023 for cruise lines and industry watchers.
In a note to investors, Morgan Stanley singled out 2023’s wave season as underperforming, contrary to rosy press releases from lines that had, for months, trumpeted an unending series of best booking days.
There are also positive sentiments worth noting. “Our channel checks saw some agents we spoke to mention improving interest in 2023 sailings, with inflation/recession concerns less prevalent, and the industry starting to see a more normal booking pattern with longer booking windows,” Morgan Stanley analysts wrote. “Smaller luxury vessels continue to gain in popularity, and with most ports now fully open worldwide, exotic cruise demand is strong.”
But analysts noted that some agents they spoke with “highlight a slowdown in bookings over the holiday period, concerns around Covid/mask mandates returning after the significant increase in cases in China, and continued concerns around the economy/inflation.”
“Some agents mentioned they are seeing difficulty in filling large mainstream ships,” Morgan Stanley concluded.
That information is contrary to what Royal Caribbean listed in its fourth quarter 2022 filing. “Booking volumes in the fourth quarter were significantly higher than the corresponding period in 2019, culminating in record booking weeks for the group for both Black Friday and Cyber Monday,” the company stated. “Momentum continues into early 2023 and the company is experiencing a record-breaking WAVE season. Overall, the seven biggest booking weeks in the company’s history have occurred since the middle of November 2022, including the first five weeks of WAVE.”
Carsten Wiebers agrees, noting that a recession isn’t all bad news for cruise lines. The parity between the euro and US dollar helps newbuilds that are typically contracted in the euro, and cruise lines have a positive track record of being able to pass costs along to customers without negatively affecting bookings. Fuel cost is typically hedged, at least in part, which lessens the impact of market and currency fluctuations. And cruise lines tap into a very loyal passenger base that has helped them recover largely ahead of other travel-related industries.
One area of concern to Wiebers, however, is for budget brands catering to price-conscious consumers, which could see bookings slip if a recession were to take hold.
“Inflation and economic downturn might be mentioned when it comes to factors which have an impact on customers’ demand,” said Wiebers. “These factors have an impact on customer groups with a low budget, which rather book a brand of budget or lower contemporary segment. The higher the segment, the lower is the impact.”
The way forward
How do cruise lines ensure profitability going forward, particularly as debt matures and payments come due? Pricing is the answer. While cruise lines have endeavoured to keep base fares somewhat consistent with 2019, either at or slightly above historical levels, onboard prices continue to rise.
Cruise lines have also begun adding value-add packages that, while offering passengers more perks and inclusive amenities, seek to wring out even more revenues from passengers before they even set foot aboard the ship.
In early February 2023, Princess Cruises announced more additions for its two value-add packages that included perks like inclusive gratuities, onboard beverages, and even fitness classes. On a weeklong voyage for two, the top-tier package can add another $1,120 to the purchase price of a cruise – a sum that could never be absorbed in the traditional fare model without scaring away passengers and driving down demand.
For cruise lines, navigating the financial fallout caused by the Covid-19 pandemic will be a constant challenge to fine-tune pricing and load factors while maintaining their onboard experience, in spite of supply chain woes and a looming global recession. It is a balancing act that will carry them well into the end of this decade and beyond.
The storm may be over, but, for debt-laden cruise operators, the danger still very much remains – and it comes in the form of something unknown, an element out of control for both companies and investors.
“The greatest threat to the cruise industry is again a black swan event, like the pandemic lockdown of 2020,” concluded Wiebers.
