Why Are Cruise Stocks Still Dead in the Water?
Carnival, Royal Caribbean and Norwegian have largely recovered from the pandemic, but investors are wary
By Spencer Jakab
This time last year, Carnival was the Nvidia of the seas.
The cruise line was the top-performing large company in the U.S. during 2023’s second quarter, with a nearly 70% gain for its shares.
Numbers two and three were its competitors Royal Caribbean and Norwegian Cruise Line Holdings.
Business has continued to improve, but investor sentiment hasn’t: Shares of both Carnival and Norwegian have taken on water since that rally.
That pessimism presents a buying opportunity for stock of all three cruise lines.
Shareholders recently got a lot more information about the industry following the end of another wave season—the period between the holidays and March when many cruises are booked—and all of them beat expectations.
Discussing its “charting the course” strategy last week with investors, Norwegian boosted its financial guidance for the year, giving its shares a bump that mostly faded within a couple of days.
Likewise, when Carnival’s chief executive reported in late March that the company had edged out analyst expectations for its fiscal first quarter with a “phenomenal wave season” and progress toward its “SEA change” goals (there are lots of nautical-themed turnaround plans), coverage instead focused on the minor financial impact of the Baltimore bridge collapse.
Carnival’s shares are down 12% since that release.
Royal Caribbean, which garnered positive coverage for its launch of Icon of the Seas, the world’s largest cruise ship, is a standout in terms of both share-price performance and repairing its balance sheet from the pandemic.
But the good news isn’t limited to that company.
“It doesn’t make a lot of sense,” says Ken Kuhrt, a portfolio manager at Ariel Investments who follows the industry closely and owns shares of both laggard Norwegian and leader Royal Caribbean.
Why aren’t cruise stocks getting enough love?
Some of last year’s gains were a relief rally.
Late in 2022, customer numbers were still below prepandemic levels and debt levels were alarming.
The more indebted cruise lines are still seen as “levered consumer-discretionary names,” says Kuhrt, meaning that middle-class spending weakness might hit them especially hard.
That hasn’t happened yet, and cruises’ superior value proposition relative to more-expensive vacation options across the board has grown since 2019.
One issue: The stocks don’t seem obviously cheap enough to compensate for that risk when viewed through the usual valuation prism.
Based on consensus analyst estimates compiled by FactSet, the three major cruise lines’ prospective 2025 price/earnings ratios range from 8.9 times for Norwegian to 11.7 times for Royal Caribbean, compared with an average forward multiple of 13 times for the industry in the five years before the pandemic.
Considering how much more expensive the stock market is today in general, that is good but no screaming bargain.
The picture looks a lot more compelling when one considers how much cash the companies are throwing off and how it is being deployed.
The sector’s collective free cash flow—what is left over from operations after capital expenditures—is seen approaching $5 billion this fiscal year and next and has never been higher.
By 2027, it should be closer to $9 billion.
If expressed as a percentage of their collective market value, a figure called free cash flow yield, the industry would then yield about 13.5% compared with around 5% today for the S&P 500.
How all that excess cash gets used matters, too.
Investors tend to focus on dividends and stock buybacks, both of which ground to a halt during the pandemic for cruise operators.
Those reward shareholders by handing them cash directly or indirectly by giving them a greater claim on future profits.
A third possibility, paying down debt or building up cash, seems underappreciated.
It especially matters when a company carries a lot of expensive debt after a period of financial distress because it can produce impressive savings.
Unlike companies that are happy to hang on to cheap borrowing accrued when interest rates were low during the height of the pandemic, junk-rated cruise lines benefit from unloading financial ballast as quickly as possible.
To name just one example, Carnival announced a series of note and loan redemptions and refinancings in late April that the company said would save it about $50 million on an annualized basis.
Yes, management teams could spoil things by engaging in a price war, but there is little reason to do so with load factors around 100% and customers booking further in advance.
Entering into a round of cruise-ship new builds could hurt too, but not for about four years given the lead time required by specialized shipyards.
Before that happens, many older, less-efficient ships will head to the scrapyard.
The sector’s recovery has been rewarding.
It isn’t too late to get on board.
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