Over the past month, the world's biggest cruise companies have proven they can raise billions in cash from investors willing to ride out the COVID-19 crisis. Carnival (NYSE:CCL) and Royal Caribbean Cruises (NYSE:RCL) have months of or even years of cash to endure the novel coronavirus pandemic, and the stock market has responded positively to their improved liquidity. But now the questions facing the industry go from short-term liquidity to long-term profitability.
This weekend's news that Warren Buffett has sold all of his airline stocks because he thinks there's going to be a structural change in travel has to be concerning for cruise lines as well. Here's why I'm more worried about 2021 and beyond for cruise lines than I am about the next few quarters.
Travel could be down significantly
We know that economic activity is down right now and many parts of the economy may not recover. Restaurants, movie theaters, salons, and gyms are just a few of the businesses that will be directly affected by COVID-19, and millions of workers will be impacted and will likely reduce their spending and travel. On top of that, businesses and consumers may think twice about traveling over the next year or two with the risk of COVID-19 hanging over the airline industry.
Buffett put it this way when discussing airline travel: "I don't know that three, four years from now people will fly as many passenger miles as they did last year." The sentiment is certainly understandable for airlines, but a certain amount of airline travel will be necessary for business or leisure because there's a tangible benefit to getting from one place to another faster than driving or taking a boat.
The same can't necessarily be said for cruise lines. This is a purely discretionary consumer purchase and there may simply be a decline in this kind of vacation in the future.
Who is going to take cruises with COVID-19 still around?
We don't yet know what demand for cruise ships will look like when COVID-19 passes or risks subside, but early indications don't look good. Management said in a quarterly filing that between the end of February and March 15, 2020, 55% of guests offered a refund or cruise credits on canceled voyages had chosen the refund. Remember, that was early in the current pandemic and well before we knew ships would be in port for months on end.
Bookings are extremely significant because at the end of February, Carnival had $4.7 billion of customer deposits, which may ultimately dry up.
Carnival and Royal Caribbean can certainly take more precautions to prevent the spread of COVID-19 than they did a few months ago, but customers are going to have to make a choice about what level of risk they're comfortable with. According to a report from Bloomberg, Carnival alone has seen over 1,500 people infected on its ships, with dozens perishing from the virus. That's more than a small customer relations problem.
Cruise lines also need customers to come back in large numbers in late 2020 and 2021 (if cruises continue). There are incredible fixed costs associated with owning ships, paying staff, and operating vessels, and losses could pile up if customers don't come back quickly. Buffett thinks there will be a structural decline in airline travel, and I think the long-term drop in cruise demand will be even worse.
A hole that can't be filled
There's a lot working against cruise lines long-term. Demand is likely to be down simply from the economic fallout of COVID-19. Then there's the likely reduction in demand from customers who don't want to take the risk of going on a cruise.
Carnival and Royal Caribbean may now have the liquidity to get through the current COVID-19 crisis and begin operating again later this year or in 2021. But when they set sail, I don't think demand will return very quickly -- and like airline stocks, that could leave the industry oversupplied. The potential for losses if that happens will keep me out of cruise line stocks for the same reason Buffett recently sold airline stocks.