Cruising can be a lot of fun and consumers have been increasingly turning to the vacation option. That trend is unlikely to change over the long term, but there's an important wrinkle here that investors shouldn't ignore when looking at industry leaders Carnival Corp. (CCL -0.66%) and Royal Caribbean Cruises (RCL 2.27%). Read this before you buy either of these stocks.
Up, up and away
Carnival's stock has experienced a dramatic rise of around 85% over the past year. Royal Caribbean shares have done even better, up more than 120%. For comparison, the S&P 500 index has advanced roughly 20% over the same span, which most investors would consider a very compelling performance. The two cruise lines put the market's gain to shame.
There is no question that investors have had very good reasons to be bullish about Carnival and Royal Caribbean. For example, after the stocks plunged in 2020, revenue and earnings for both companies have recovered strongly. And bookings remain solid for both cruise lines. For example, Carnival noted in its fiscal fourth-quarter 2023 earnings release that it had record 2023 revenue, record booking volumes over the Black Friday/Cyber Monday selling period, and that the fourth quarter saw customer deposits 25% above previous record levels. In Royal Caribbean's third-quarter 2023 earnings release, CEO Jason Liberty noted, "Our booked load factors are higher than all prior years and at higher rates." At this point, it looks like both companies are probably going to have pretty good years in 2024.
Wall Street is forward-looking
But given the huge gains in the shares of both cruise stocks, it seems like investors may already be pricing in a lot of that good news. Indeed, even if the positive outlook among investors is justified, 80% plus share price gains in a year is something that should cause you to step back and carefully consider your investment decisions. Trees don't grow to the sky, as goes an old saying about getting too positive about good trends.
The big problem here is that cruising is, at best, a luxury service. So demand will wax and wane along with economic activity. If there's a recession, investors are likely to dump Carnival and Royal Caribbean. It's not fair to look at the pandemic as a reference point here (given the government mandated closures), so it's best to go back to the Great Recession. As the chart below illustrates, these two stocks can get hit hard during a weak macroeconomic environment as the market assumes that customers will pull back on spending.
The problem today is that, valuation wise, it is hard to get a good read on what these two companies are worth because of the massive impact of the pandemic period. Notably, Carnival's stock is still far below its pre-COVID levels while Royal Caribbean is only back to where it was before that illness upended its business. So it isn't that hard to think that there's more upside potential here.
That said, credit card debt hit an all-time high in 2023 and delinquency rates are heading higher. Meanwhile, large banks like Bank of America have been adding to their loan loss reserves, which is what they do when they are expecting an increase in the number of customers who are unable to pay their loans. There are clear signs that the U.S. economy isn't hitting on all cylinders right now. All it would take is some negative economic news and Wall Street could start to run for cover, which would likely hit Carnival and Royal Caribbean shares particularly hard, given their impressive advances.
More downside than upside at this point
There's nothing wrong with Carnival or Royal Caribbean and it seems like 2024 will be a strong year, business-wise, for both at this point. However, given the big price advances over the past year, it is also pretty clear that Wall Street recognizes this fact already. And with so much good news already priced in to the stocks, investors have to consider how much further there is to run versus what happens if the story shifts in a negative direction. More conservative investors and those with a value bias might want to tread with caution here.
