What happened
Shares of AMC Entertainment (AMC -3.25%), Carnival (CCL 1.49%), and Norwegian Cruise Lines (NCLH -0.77%) fell again on Wednesday after a tough month of June, down 3.3%, 6.3%, and 9.9%, respectively, as of 1 p.m. ET.
There wasn't any material news out of these companies today, but they all have two big things in common that are causing them to fall. First, each is a consumer discretionary stock, and it's clear consumers are cutting back amid high inflation for food and fuel. Second, each of these companies had to load up on debt during the pandemic. Not only do they now have the added burden of interest expenses, but with interest rates now higher, any refinancing would be expensive.
With the Federal Reserve now signaling its primary goal is to lower inflation, not avoid a recession, heightened recession fears are decimating these stocks.
So what
Of note, AMC is falling despite Minions, Rise of Gru shattering the previous July 4 weekend box office record last weekend, raking in $125.2 million in the U.S. That exceeded the previous record set by Transformers, Dark of the Moon back in 2011. Combine that with the success of the new Top Gun movie, and movie theaters appear to have had a pretty nice run in June and July.
So what's the problem? Well, Minions is only one movie, and AMC needs more sustained moviegoing to get back into the green. AMC hasn't had a profitable quarter yet coming out of the pandemic, and it still has a heavy debt load, with $5.5 billion in debt versus $1.2 billion in cash. The company also burned through $330 million in cash in the first quarter, giving it just four quarters of runway. Although the second and third quarters should be better, given the success of Top Gun and Minions, will it be enough to get back to cash flow positive? With lower-cost streaming options at home, a recession wouldn't help.
The same goes for cruise line stocks Norwegian and Carnival. Although there is huge pent-up demand for travel, these two companies now have to deal with higher fuel and interest rates. But oil prices and long-term interest rates have been falling since the Federal Reserve hiked rates by 75 basis points in mid-June, so what is going on?
Falling oil and interest rates signal a cooling of demand, and potentially a recession. Meanwhile, the cruise lines all need to achieve high load factors in order to get back to profitability and pay their interest costs. The cruise lines are not registered in the U.S., and therefore got less help from the government during the pandemic. Both Norwegian and Carnival therefore had to take on lots and lots of debt to survive.
Last month, one analyst at Morgan Stanley declared Carnival's debt looked "unsustainably high." Meanwhile, Carnival still logged a $1.9 billion pre-tax loss last quarter alone. Norwegian had a pre-tax loss of nearly $1 billion. Even if they do return to profitability this year, it will take a lot of time and effort to pay back their higher debt loads.
Of course, results should get better for each company relative to the first quarter, as omicron fears were still a concern early in the year. Nevertheless, with recession fears in the air amid Fed tightening, the promise of demand roaring back is now in question. That doesn't just mean less-than-stellar results; these companies need strong demand, perhaps just in order to survive.
Now what
There is a high degree of uncertainty right now about the path of inflation and the economy. While it's still possible the Fed engineers a "soft landing," in which inflation cools without the economy going into a bad recession, that is highly uncertain. Also keep in mind, each of these companies has a significant European business, and Europe is in even more dire straits than the U.S.
Given the high uncertainty, investors should probably turn to companies with much better balance sheets and less discretionary exposure. No doubt, if things improve, these stocks could come roaring back; however, there is also the very real possibility these companies could go bankrupt, or at least dilute shareholders further. With so many high-quality companies down significantly in this market, these three don't seem worth the risk.
