It's awfully tempting to nibble on cruise line stocks these days. Industry leader Carnival (CCL 0.30%) (CUK -0.34%) is trading 72% lower in 2020, and smaller rivals Norwegian Cruise Line Holdings (NCLH -0.48%) and Royal Caribbean Group (RCL -0.66%) are also among this year's biggest losers.
With so many market darlings trading sharply higher and the market now firmly in positive territory, there's going to be some bottom feeding among the cruise line stocks. It could be a big mistake. A fatal flaw in chasing a sinking stock lower is assuming that the ceiling is suddenly higher. Carnival's stock can triple from here and still not be where it was when the year began. That's the upside only if the cruise line operator can get back to where it was at the end of 2019. Unfortunately for Carnival and its speculators, it's not going to return to form anytime soon.
The current plight of the industry is pretty well anchored. All of the major cruise lines have cancelled their U.S. as well as most of their international sailings through at least early November. Roughly half of the passengers on suspended sailings have asked for their money back. The other half have agreed to accept sweetened credit on future sailings. We're eyeing a cash flow crunch even once Carnival and its peers are back on the open waters.
The good news is that Carnival has raised over $10 billion through a series of financing transactions. Pair that up with the shaving of billions in operating costs and capital expenditures after scaling back its fleet through the shedding of assets and deferring new ship deliveries and Carnival will survive. A month ago it said it had enough liquidity to sustain itself for another full year, and it has continued to make financing moves.
The bad news from an investing standpoint is also everything mentioned earlier as good news. The price of the additional liquidity is that more debt translates into more interest expense, and that means lower profits. More shares issued in financing efforts reduce earnings on a per-share basis. Even if Carnival's fleet was at full strength it would not land anywhere close to last year's peak profit level.
A few weeks ago, Deutsche Bank analyst Chris Woronka offered a glimpse at Carnival's diluted and expense-saddled future. Between the extra $850 million in interest expense he figures the cruise line will be facing by 2023 and the larger share count, the $4.40 a share it reported in earnings last year would be just $2.88.
In reality, the future could be even less profitable. Demand isn't going to bounce back anytime soon even if a successful vaccine is cleared. A lingering recession will keep prices in check, even with fewer ships in Carnival's portfolio.
Things don't have to end badly for Carnival. The economy could bounce back quickly, and consumer sentiment on the safety of cruising may be repaired sooner rather than later. However, assuming that Carnival simply needs to get back to where it was when it was in peak form last year for the stock to reclaim its former highs is not reasonable. The ceiling isn't as high as many investors think, and overestimating the near-term gains here is the worst mistake Carnival stock investors can make.