What happened
A leading Wall Street analyst has raised doubts over whether one of the largest cruise ship operators could survive another demand shock like a new pandemic wave. Investors are abandoning ship as a result. Shares of Carnival (CCL 3.47%) (CUK 3.32%) are down 15% on Wednesday morning, while shares of Norwegian Cruise Line Holdings (NCLH 4.13%) and Royal Caribbean Cruises (RCL 3.36%) are down 10% apiece.
So what
The cruise lines were hit hard by the pandemic, and the recovery to date has been choppy. There is a lot of pent-up demand for vacation travel, but only so many consumers who are eager to spend a week in a confined space with thousands of other guests.
Morgan Stanley analyst Jamie Rollo is worried the industry could capsize should anything else go wrong. On Wednesday, the analyst cut his price target on Carnival to $7 from $13 following last week's "weak" second-quarter earnings report. Rollo forecasts a full-year EBITDA loss of $900 million by Carnival due to weakened pricing, lower-than-expected occupancies, and higher fuel costs.
Rollo also notes that Carnival has $4 billion in debt maturing over the next 18 months, and about $5 billion of its cash cushion is customer reserves. If debt markets get tighter, or there is another demand shock that hits bookings and causes customers to withdraw deposits, he fears Carnival could face a liquidity crisis. In this bear case, Rollo warns, the value of the equity could be wiped out.
Some of these issues are specific to Carnival, but there is enough industrywide gloom and doom for shares of Norwegian and Royal Caribbean to get caught up in the current. The cruise companies have been adrift for nearly three years now, and we're still very much not out of the woods in terms of the pandemic. A combination of rising interest rates and the economic slowdown that could follow threatens to crimp consumer spending, which would hit demand for big-ticket discretionary purchases like cruises.
Now what
It's important to note that Rollo's views are not universal. Overnight, Barclays analyst Brandt Montour initiated coverage of the industry. Montour is bullish on both Carnival and Royal Caribbean, giving both stocks overweight ratings, and he rates Norwegian as equal weight.
The bull case for cruise lines is the industry's loyal customer base, and the hope that strong demand for cruising will offset higher fuel costs and allow the industry to power through whatever rough waters lie up ahead. With international travel still subject to some restrictions, cruise lines offer a relatively simple option for those looking to get away.
The bottom line is that while Rollo's worst-case scenario isn't the most likely outcome, there are enough concerns to believe the industry will be treading water for the foreseeable future. Given the uncertainty surrounding the economy, investors have every reason not to rush to climb aboard these stocks for now.
