Looking at the stock market, it's hard to believe we are in the middle of a pandemic and one of the sharpest recessions in recent memory. With the exception of hard-hit industries like cruising and air travel, stocks have recovered most of their earlier losses, putting the S&P 500 on track for positive year-to-date performance.
If you missed out on the big rally, you might be tempted to invest in cruise stocks like Royal Caribbean (RCL 0.12%) while they are still cheap. Here's why that would be a mistake.
Royal Caribbean's September restart date looks too optimistic considering the rapidly resurging coronavirus pandemic in the U.S. The company's weak balance sheet and equity dilution could also keep the stock suppressed over the long term. Let's dig a little deeper.
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1. The September restart date looks too optimistic
On July 14, the cruise industry received a much-needed shot in the arm after promising vaccine trial news from American drug maker Moderna. Moderna hopes to have a COVID-19 vaccine available for broad distribution by the end of 2020 or early 2021, according to the company's CEO Stephen Hoge.
But while this development is great news for the industry, the vaccine probably won't come in time to help Royal Caribbean meet its overly-optimistic restart timeline.
Royal Caribbean plans to start sailing again on September 16, if health authorities allow it. Technically, this timeline is possible because the current CDC-mandated no-sail order is set to expire 100 days from when it was first extended on April 15 (which is July 24). However, the rising number of coronavirus infections in the U.S., makes it increasingly likely that the CDC will extend its restriction for an additional 100 days -- which would make Royal Caribbean's September restart date impossible.
The U.S. cruise industry could also face challenges from foreign ports that are unwilling to accept American tourists. Several countries in the E.U. and Asia maintain restrictions on U.S. passport holders, although Latin America and the Caribbean are significantly more accessible.
2. Heavy debt load and rising interest expense
Royal Caribbean needs to restart operations as soon as possible because of its high cash burn and spiraling debt load. The problem is that, even if the company survives the crisis, it will be left with a large pile of high-interest loans and dilution that could suppress cash flow and cause the stock to underperform the market over the long term.
Royal Caribbean reported long term debt of $12.27 billion in the first quarter, a sum larger than its $10 billion market cap.
In June the company closed a private offering for an additional $1 billion in 9.125% senior guaranteed notes and $1.15 billion in 4.250% convertible senior notes, (which could lead to dilution if the creditor decides to swap them for equity) due in 2023. This capital raise follows a May offering for $1 billion in 10.875% notes and $2.32 billion in 11.5% notes due in 2025. This high interest/early maturity debt will put a tremendous strain on Carnival's free cash flow in the coming years.
The company reported interest expense of $408.5 million in fiscal 2019 which was around 20% of the years $2.08 billion operating income. Investors can expect these figures to worsen dramatically in fiscal 2020.
Takeaway
At a current price of around $58, Royal Caribbean stock is trading at a significant discount to its pre-pandemic high of $135. But the stock is cheap for a reason, and investors shouldn't ignore the market's warning.
Management's September restart date looks too optimistic considering the rapidly rising number of Covid-19 infections in the United States. And the company's dilution and heavy debt load will keep negative pressure on the stock, even when the pandemic subsides. The company will probably continue to underperform the market because of these challenges.
