Description

Cruise lines and CCL in particular look incredibly vulnerable to future solvency questions.  The stocks currently trade at full multiples on earnings that exceed pre-pandemic levels.  The assumptions behind these forecasts are highly flawed.  There is a real risk that the equity market comes to this conclusion in the near-term and refuses to fund this bridge to nowhere.  Meanwhile retail enthusiasm and short-interest have declined markedly.  As such, the largest remaining source of marginal traders would be renewed interest on the short side and long investors who can not believe these forecasts make a lot of sense (especially retail.)  Any one with a brain on the longside has to wonder what the upside is on 2023 earnings/multiples.  So - if you are looking for a re-opening short where the data IS NOT inflecting to the upside (airlines, hotels, restaurants) and a favorable technical set-up (low short-interest and weak hands on the long-side)...  I think this idea timely.   I would play this two ways.  A) Short for a trade while re-open sentiment is crashing on variants and positioning.    B) Structural short as these stocks are likely to generate a negative IRR through 2023/24 and possibly run into solvency problems when they are over-supplied - unless they materially dilute shareholders.

Short thesis:

1)            Robust supply growth:  Shipping is where money goes to die.  This applies to nearly all segments.  The fixed investment to build a ship is huge.  All sorts of counter-parties are anxious to cheaply fund expansion to employ local populations.  This applies to the cruise industry which has a long history of expansion of the fleet on a total number of ships and berths/ship.  Unlike many industries that cut massive amounts of capacity during the pandemic, the cruise industry continues the at a torrid pace of expansion of the fleet that was set pre-pandemic.  These new and enormous ships will continue to roll-out of the shipyards.  The industry will have you believe that they have de-fleeted, driving reduced capacity.  This could not be further from the truth.  They have sold their ships to smaller players who will operate these ships once demand comes back.  These ships have not been scrapped.  As a result, supply will be demonstrably higher.  While CCL scrapped 12% of its high cost/old capacity which generated 3% of EBITDA, it’s order book is huge.  The big publics will have 18% more capacity as of 2023 vs 2019.  This reminds me a lot of the oil drillship debacle.  Massive amounts of capacity continued to roll out of the shipyards in 2016, 2017, 2018, 2019 – as demand declined each year.  Admittedly, the demand outlook is here is not nearly as dire.  However, I believe the initial green-shoots on demand have been HIGHLY misleading and the bull case is fully priced.

2)            Demand recovery will prove lackluster:  The industry has been heartened by the robust booking levels at price points which reportedly exceed 2019 levels.  THIS IS HIGHLY misleading.  There are no consequences to cancelling.  Why not book a cruise as a free option?  The price structure of cruises is normally highly depressed by the last minute (month or two) bookings which come at a large discount as operators realize the marginal cost of another passenger is extremely small.  The current bookings lack any of this as you can’t book a cruise until 2022 now.  As we get closer to the departure dates, travelers will need to consider the following and will delay or cancel which will materially reduce the yield on an average room.  The greater the deferral… the greater the price decline. 

A)  Do passengers want to pack into close quarters where disease spreads rapidly with people from all over the world and unvaccinated passengers?  There will be new variants and your vaccine may not have efficacy.  If you get sick, you may be stuck on a floating prison for the duration of your cruise. 

B)  If you are among the 30%+ of Adult population in Europe/US that refuses to vaccinate, do you want to get on a cruise ship?  You may not want to get vaccinate but you probably don’t want to get Covid on a cruise ship.  THIS IS A HUGE PROBLEM FOR AN INDUSTRY THAT NEEDS TO SEE A MASSIVE SURGE IN DEMAND.

C)  Will you put your kids on a ship without a vaccine?

D)  Do potential customers want to travel to foreign countries which have different standards and vaccination levels?  C)  will local regulatory authorities allow ships to sail? 

E)  Does a Biden CDC allow this super spread event occur; especially as re-opening the cruise ship industry will incentivize foreign travel to the US?

It is important to note that cruise passengers skew older, obese and highly risk adverse.  FOR ALL OF the above REASONS, I suspect that travel demand will NOT be 25-30% higher than 2019.  Note:  demand needs to be 25-30% higher than 2019 to drive higher yield on 18% more capacity.  Further note:  IF DEMAND IS only 110% larger than 2019, EVERYTHING will fall apart.  Frankly, Covid should largely be behind us but all of the above issues will plague this industry.  There will be 5-15% of the population that will remain in an extremely huddled stance as it relates to crowding.  The same way that Asian populations adopted masking wearing for a decade after the SARS scare (not a pandemic).  Marginal cost of an additional passenger is the cost to clean the room and a $50 of food/drinks.  If berths are empty, the race to the bottom will ensue.  Cruisers will cancel their high priced cruise and rebook at lower rates.  Is there pent up demand for travel, yes.  Will 5-15% of the populuation wring their hands as it relates to cruising while the remaining 85-95% will only get the same amount of vacation?

3)            Management teams don’t believe the forecasts.  They continue to sell stock into rallies despite massive war-chests.

4)            FCF burn.  5bn/year until they can sail.  The CDC reaffirmed their November 2020 restart yesterday.

5)            Valuation:  The stocks today trade at 8x 2023 EBITDA when you include 2021 FCF burn.  This EBITDA is demonstrably higher than 2019 for all of the broken reasons I mention above.  This is unlike other stocks that will almost certainly have upside as normal activity resumes and we grow into potential.  Cruise ships price in a scenario that will likely prove to be wildly optimistic.  This is a terrible industry that does not return its cost of capital over the cycle due to constant over-supply.   FCF generation is meek.  8.0x EBITDA is about as good as it gets.

7)            Oil price sensitivity:  if we get a surge in travel demand such that cruise demand is 30% higher than 2019, oil is likely to be more like 80-120+/bbl. 

Catalyst

Lack of upside catalysts