If you like choppy seas, the cruise line stocks have been a trader’s paradise over the past month. The sector capsized once the novel coronavirus hit. For awhile, it looked like cruise stocks were heading straight to zero. But over the past week or two, traders have hoarded names like Royal Carribean (NYSE:RCL) again. First, it was on hopes of an imminent government bailout. Even after that largely fell through, RCL stock bulls pivoted to hopes of the virus peaking.
Prominent investors like Bill Ackman have suggested that society may be nearing so-called “herd immunity,” which would allow us to get back to normal life relatively quickly. For airlines, cruise lines, hotels and other travel companies, it’s imperative that people get back to ordinary routines as quickly as possible.
Not only are cruise lines out of action for now, the longer the economy stays shut down, the more unemployment numbers mount. Needless to say, if people can’t get back to their old jobs and earn good salaries, they won’t be booking vacation plans in the near future either.
In any case, this herd immunity idea had travel stocks soaring last week. Royal Caribbean in particular surged from a low of $19 to more than $40 at one point.
However, RCL stock’s recent winning streak hit an abrupt end on Monday. Shares slumped 17% as traders evaluated the company’s outlook. Given indications that more states will remain in shutdown mode through at least May, folks started dumping travel stocks heavily again. With so much uncertainty, that’s the right move. Here’s why.
Troubled Balance Sheet
Late in March, Royal Caribbean fully tapped its $2.2 billion line of revolving credit. That, plus its previous supply of cash, boosted its treasury up to $2.5 billion. Bulls celebrated, as that seemed like a significant amount of liquidity while the company faced down the coronavirus.
But, upon closer reflection, it likely won’t be enough. As of year-end 2019, the company had $4.5 billion of normal current liabilities. Those are expenses that are very difficult to push off for more than a quarter or two. That is, clearly, much larger than the company’s cash pile. On top of that, Royal Caribbean had $3.4 billion in customer deposits for upcoming voyages; the company may end up needing to refund much of that as well. This is leaving aside the company’s massive long-term debt, as that’s not an immediately pressing problem. Even so, short-term liabilities could sink the company unless it can raise more cash fast.
Debt Markets May Be Available, But at a Steep Price
A variety of distressed companies have tried to tap credit markets in recent days. It’s particularly instructive to look at other companies that rely on consumer spending within the travel and experiences categories.
In movie theaters, for example, operators have gotten mixed results. Cinemark (NYSE:CNK) was able to get $250 million in bonds issued this week. Unfortunately, it wasn’t cheap money. Cinemark will be paying 8.75% a year for access to this relatively modest sum, and making matters worse, it will have to repay the debt in 2025. That’s an awfully short duration on a loan at such a steep interest rate.
Within cruise lines, Carnival Cruise Lines (NYSE:CCL) was able to raise money. But it came at an exceptionally steep price, with the senior bonds going off at a more than 11%/year annual interest rate. And don’t forget that, prior to this crisis, Carnival had the best balance sheet in the sector. If it had to pay more than 11% to get money, it suggests a potentially awful outcome for the comparatively weaker Royal Caribbean and Norweigan Cruise (NYSE:NCLH).
RCL Stock Verdict
There definitely could be a bounce back trade for Royal Caribbean in a few months. Sooner or later, we’ll get a more clear timeline. Once we have some idea when the virus will be under control, when vaccines or other measures will be available, and social distancing can be lifted, stocks like Royal Caribbean could recovery sharply.
For now, though, it’s way too early to get involved here. Even the strongest player in the space, Carnival, just took on a painful deal to raise cash. In addition to the high-interest debt, Carnival also had to issue additional equity at just $8/share, down by more than three-quarters from its pre-crisis levels. What sort of price will Royal Caribbean potentially have to pay to raise billions of its own?
Things could still work out alright for the firm in the short-term. If the cruise lines figure out how to get a big chunk of bailout money, for example, that would make a huge difference. But that sort of positive outcome is a pure gamble at this point. The clock is ticking, and the liquidity situation grows more difficult the longer stay-at-home orders remain in place. Unless something unexpected happens, Royal Caribbean is likely to resume trending sharply lower in coming days and weeks.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.