what happened
Shares of Carnival (CCL 0.21%) (DICK 0.48%) fell 6.3% this week from where they closed last Friday, according to data provided by S&P Global Market Intelligence, as worries about economic woes took hold of the cruise ship operator.
The battered stock was hit this week by prospects that the Federal Reserve will continue its aggressive stance against inflation and continue to raise interest rates, a move that would make the cost of borrowing much more expensive for Carnival.
Image source: Getty Images.
And what
In an effort to stay at sea during part of the pandemic lockdown, Carnival and cruise operator Peer Norwegian Cruise Line Holdings AND Royal Caribbean Cruises got into a lot of debt. Cruise lines still had significant expenses, such as ship maintenance and paying crew, and they had no money coming in.
Norwegian and Royal Caribbean have practically doubled the amount of long-term debt they carry on their balance sheets compared to before the pandemic to $12 billion and $18 billion, respectively. Carnival nearly quadrupled to $35 billion.
An intention by the Federal Reserve to raise interest rates will weigh heavily on the world’s largest cruise operator, especially because it and others are not yet operating at 100% capacity, thus limiting their revenues.
Now what
As my colleague Rich Smith recently pointed out, “for every 1% that interest rates rise, Carnival needs to earn $196 million more per year just to break even.”
It faces additional rate risk next year as global financial institutions switch from US dollar LIBOR, or the London Interbank Offered Rate, to SOFR, the Secured Overnight Funding Rate. The first is based on forward-looking estimates to determine rates, the second is backward-looking based on the cost of borrowing overnight cash collateralized by US Treasuries.
LIBOR will disappear on 23 June 2023 and be replaced by SOFR, which is creating a lot of uncertainty about how interest rates will be affected, not just with Carnival, but businesses in general. Most of Carnival’s debt is variable rate and would be affected by how rates are set. How much the carnival will cost will depend on how much the Fed raises rates to fight inflation.
Fortunately, there remains significant demand to take cruises, and Carnival reports that its bookings were “almost double the level” for the same day in 2019 after it lifted its COVID-19 screening requirements and announced that unvaccinated passengers now can sail.
