What happened
In a surprise announcement this morning, cruise line company Royal Caribbean (RCL 0.04%) -- which just finished reporting better-than-expected (but still unprofitable) financial results last week, lifting its stock price -- is sinking fast on news that the company has decided to issue at least $900 million, and perhaps as much as $1 billion, in new debt.
As of 9:50 a.m. ET, Royal Caribbean stock is already down 9.6%, and its news is sinking peer cruise line companies Norwegian Cruise Line Holdings (NCLH -0.77%) and Carnival Corporation (CCL 1.49%) (CUK 1.34%) alongside it. Norwegian stock is down 4.2%, and Carnival is off 4.5%.
So what
Just about a month ago, Carnival Corporation reported second-quarter earnings in which it warned that, contrary to analyst forecasts, it would not in fact earn a profit in the third quarter. As if to emphasize the point, three weeks later, Carnival announced it would raise between $1 billion and $1.15 billion in cash through a new stock offering to tide it over until profitability returns.
Today, Royal Caribbean appears to be following the same playbook: announce earnings, warn that there will be no profits in Q3, and then raise cash. Specifically, Royal Caribbean informed investors this morning that it will sell up to $900 million worth of "senior convertible notes to be issued by the Company due 2025," plus a further $135 million if underwriters exercise their overallotment option (so $1 billion-plus in all).
Now what
Royal Caribbean intends to use the new debt to roll over old debt -- two batches of convertible debt paying 2.875% and 4.25% interest, respectively -- and to therefore extend the amount of time it has to pay back its debts. The company did not say what interest rate its new debt will pay. Presumably, though, with interest rates on the rise, the new debt will be more expensive than the old, and Royal Caribbean's interest costs will rise accordingly.
And so I fear what we have here, folks, is a pattern. Two out of the three big cruise companies have reported losing money in Q2, promised to keep losing money through at least Q3 -- and raised cash to prepare for more lean times. Today's news concerns Royal Caribbean most specifically, which is why it's getting hit hardest. But there's still one more cruise company that needs to report: Norwegian Cruise Line, earnings for which are due out on Aug. 9.
If you're an investor in the cruise sector, I think it's probably best to assume that Norwegian's news next week will be similar to all the rest. Earnings will be negative. (Indeed, analysts are predicting an $0.86 per share loss.) Norwegian will warn that it's going to be unprofitable in Q3 as well. And chances are good that Norwegian will announce a debt or equity offering -- or both -- shortly after earnings come out.
Cruise investors need to assume that interest costs will be higher, positive earnings will take longer to return, and when they do, this industry as a whole will be a lot less profitable than it was prior to the pandemic. Invest accordingly.
