Cruise Line Stocks Aren't Recession-Proof, Don’t Rush to Buy the Dip

Even if 2022 wasn’t already a tough year for cruise line stocks, they received another jolt when Morgan Stanley issued a bearish report on cruise company Carnival. On June 29, not only Carnival but other cruise stocks like Norwegian and Royal Caribbean also fell. Should you buy the dip in cruise line stocks yet or wait?

Cruise stocks are among the worst performers in the S&P 500 in 2022. The price action isn't much different from 2020 when cruise and energy stocks were at the bottom among S&P 500 stocks. While the energy sector has rebounded in 2022 and is in the green, cruise stocks have fallen steeply and are trading near 52-week lows despite the wider market rebounding from the troughs.

The fall in cruise line stocks might sound counterintuitive as all cruise companies have been reporting strong sales growth and a massive increase in customer deposits. However, one reason cruise line stocks are falling is due to higher fuel costs, thanks to the steep rise in crude oil prices in 2022.

Cruise line companies managed to survive the 2020 slump where their revenues plummeted to near zero and Royal Caribbean posted negative revenues in the third quarter of 2020. However, the “survival” came at a cost in terms of higher debt and equity dilution. The massive debt that cruise companies assumed in 2020 is now coming back to haunt them, especially when fears of recession have been rising.

Cruise companies are also battling high inflation, which is putting pressure on their bottomline. While demand has been strong so far as we still have pent-up demand from the COVID-19 lockdowns, some analysts fear that a possible recession in the U.S. could lead to demand destruction for cruise line stocks.

Morgan Stanley lowered Carnival’s target price to $7. The target price is a new street low and less than half of the stock’s consensus target price. More importantly, Morgan Stanley predicted that in the worst-case scenario, Carnival stock could fall to zero. Stocks usually fall to zero when the companies go bankrupt.

Morgan Stanley believes that if there's a demand shock, it would be a drain on Carnival’s liquidity, which stood at $7.5 billion in the most recent quarter. The company holds $5 billion in customer deposits.

During the earnings call for the second quarter of 2022, Arnold Donald, Carnival’s CEO, said, “While not recession-proof, our business has proven to be recession-resilient time and again.” Recession-proof stocks are companies whose business isn't impacted much by business cycles.

The demand for leisure falls in a recession as people have less money to spend on discretionary expenses. Also, the cruise industry has been battling pricing headwinds in the short term. The pricing pressure is coming at a time when cruise companies are battling higher inflation and increased marketing expenses.

In its earnings call, Carnival alluded that if there's a recession in the U.S., it would be different from the previous ones. The company pointed to a strong job market, and high household savings to substantiate its point. It also said that there's still pent-up demand from the COVID-19 pandemic. So, even if we see a recession, the demand should hold up better than in previous recessions.

While there's merit in what Carnival said, it's important to note that the cruise industry is still reeling from a heavy debt load, and another recession in a span of two years would be the last thing that they want.

Cruise stocks have been out of favor with markets and might continue to struggle amid recession fears. While falling stock prices have made cruise line stocks look attractive, they still might have room to fall more if we indeed see a recession.