What Every Cruise Ship Stock Investor Needs to Remember

Wall Street did its best to confirm its bullish tone on Monday, as major stock market indexes gained even more ground following last week's breakout move higher. The Nasdaq Composite (^IXIC 2.02%) saw by far the best percentage increase among major indexes, but the S&P 500 (^GSPC 1.02%) and Dow Jones Industrial Average (^DJI 0.40%) both made more headway as well.

Data source: Yahoo! Finance.

Cruise ship operators have seen their share prices rebound sharply from their worst levels during the early years of the COVID-19 pandemic, as ships have returned to the high seas and travelers have sought passage to faraway destinations. Yet even though analysts are growing more optimistic about the long-term prospects for companies like Carnival (CCL -0.66%) and Norwegian Cruise Line (NCLH -1.60%), there are some simple facts about the cruise ship operators that every investor needs to take into consideration when reading these bullish views.

Riding high on Monday

Monday was a good day for cruise ship stocks. Carnival shares jumped 12%, while Norwegian enjoyed a 7% gain and Royal Caribbean (RCL 2.27%) brought up the rear with gains of about 3%.

Multiple analysts weighed in on the industry with positive comments. Both J.P. Morgan and BofA Global Research noted that levels of cruise bookings have returned to their pre-pandemic levels. Cancellation frequency has moved lower as well, indicating that travelers are more confident about their prospects to follow through on their travel plans. In particular, people remain antsy to get out and see the world after having spent their lockdown years at home.

Carnival got the most optimistic assessments from analysts. BofA upgraded the stock from neutral to buy, while J.P. Morgan moved the cruise line operator from neutral to overweight. Both analysts also made big increases in their target prices on Carnival stock, with BofA going from $11 to $20 per share and J.P. Morgan setting a target of $16 per share, up $5 from its previous call.

The moves higher were less extreme for other cruise ship stocks. Royal Caribbean's price target got lifted from $82 to $95 per share at BofA. Norwegian got a $1 boost from J.P. Morgan and a $2 increase from BofA. Nevertheless, favorable conditions should mean better prospects for the entire industry.

A big change in capital structure

What investors can't forget, though, is that the capital structures of cruise line companies are much different now than they were in 2019. Some of the companies have substantially more debt and have also issued a large amount of new stock in the past four years.

For instance, Carnival's market capitalization was at around $34 billion at the beginning of 2020 before the pandemic. It now stands at $19 billion, or a bit more than half that. Yet the stock price remains down 70%, having gone from $50 per share to $15. The disparity results from the fact that Carnival issued a large number of new shares, so each share represents a smaller fraction of ownership of the overall company. Moreover, Carnival incurred substantial new debt, and as a result, its enterprise value of $47 billion now is actually above where it was at the beginning of 2020. Similar factors are present for Norwegian Cruise Line Holdings.

Royal Caribbean has fared better, in part because it issued less new stock and debt during the pandemic. Its enterprise value is considerably above its early 2020 level, and while the share price is down, the drop has been less extreme than for Norwegian and Carnival.

Understand true value

Looking at a share price is just one component of a company's valuation. If you neglect learning about the capital structure of the business, you could draw the wrong conclusion from looking at share price alone. Even if these cruise ship companies see business return to pre-pandemic normal, that doesn't mean the stocks will fully recover in the near future.