What happened
Shares of the major cruise stocks Carnival Corp. (CCL -0.66%), Royal Caribbean Cruises (RCL 2.27%), and Norwegian Cruise Line (NCLH -1.60%) were up strongly in June, surging 67.7%, 28.1%, and 46.6%, respectively, according to data from S&P Global Market Intelligence.
It looks as though "revenge travel" after the height of the pandemic is still in high gear this summer. Earlier in the month, all three cruise lines rose when a major Wall Street analyst made a positive call on the sector. Then toward the end of the month, Carnival reported second-quarter earnings. While the stock initially fell on an outlook for higher costs than expected, eventually investors came around to focus on the blockbuster booking numbers and pricing power Carnival demonstrated, lifting sentiment for the group further.
So what
On June 12, J.P. Morgan analyst Matthew Boss turned more constructive on the sector following a series of meetings with all three companies' management teams. Following the meetings, Boss upgraded Carnival to overweight, while keeping Norwegian at neutral and Royal Caribbean at overweight. However, he lifted his price targets for all three stocks.
Boss came away with several positive takeaways, as all three management teams noted strong demand continuing for the second summer since the pandemic lockdowns. Interestingly, however, Boss was especially encouraged that the strong demand from cruise "loyalists" last summer was transitioning to demand from "new-to-cruise" customers in 2023.
As long as demand remains strong, the cruise lines should be able to begin digging themselves out of the large debt holes they find themselves in. That was confirmed later in the month when Carnival reported strong earnings that handily beat revenue expectations, while net losses were also less than feared.
While the stock initially dipped on a forecast for slightly higher costs than were expected, it quickly recovered, and then some, as investors took in the extremely strong bookings number, as well as management's new three-year plan to expand margins and pay down debt.
Carnival management noted strong bookings volumes reached a new record $7.2 billion last quarter, and were 17% higher than 2019 levels. In addition, on the conference call with analysts, new CEO Josh Weinstein outlined a three-year plan to expand EBITDA per available lower berth day (ALBD) by 50%. If management hits its targets, that could lead to an average of $3 billion in annual free cash flow over the next three years, allowing management to pay down $8 billion of the company's $33 billion-plus debt load.
Given how leveraged the cruise companies are now, the prospect of a stronger-than-expected recovery in profits could juice a strong stock recovery. On the other hand, if demand doesn't materialize, that debt is a two-edged sword that could send the stocks back down.
But so far, demand seems strong, while June's economic data came in generally quite positive as well. During the month, the job market remained resilient with very low unemployment, even while inflation continued to fall. The generally positive economic figures encouraged several Wall Street analysts to increase their probabilities for a "soft landing" scenario, in which the Federal Reserve will be able to get inflation back down to its 2% target without having to significantly harm the economy.
Since cruises are a discretionary purchase, the generally positive macroeconomic data released this month probably helped boost sentiment for cruise stocks even further.
CCL Percent Off All-Time High data by YCharts
Now what
The cruise line stocks look like a high-risk, high-upside opportunity today, as long as the economy remains strong and there are no unforeseen global issues.
Royal Caribbean looks to be the strongest of the three. It is only about 24% below its all-time highs, as it didn't need to sell as much debt and stock to get through the pandemic-related issues. However, Norwegian is still down 66% and Carnival is still 74% from their all-time highs.
As long as demand remains as strong as it is, these companies should continue to pay down debt, transferring value from their debt holders to their stockholders. And if the industry continues to benefit from strong demand for experiences and travel, it's possible these stocks could get a valuation rerating as well.
