Why AMC Entertainment, Carnival and Norwegian Cruise Lines Dropped Today

What happened

Shares of AMC Entertainment (AMC -2.88%), Carnival (CCL -6.30%)and Norwegian Cruise Lines (NCLH -9.27%) fell again Wednesday after a rough month in June, down 3.3%, 6.3% and 9.9%, respectively, as of 1 p.m. ET.

There was no major news from these companies today, but they all have two big things in common that are causing them to fall. First, each is a consumer discretionary stock, and it is clear that consumers are cutting back amid high food and fuel inflation. Second, each of these companies had to accumulate debt during the pandemic. Not only do they now have the added burden of interest costs, but with interest rates now higher, any refinancing would be expensive.

With the Federal Reserve now signaling that its primary goal is to reduce inflation, not avoid recession, heightened recession fears are killing these stocks.

So what?

It should be noted that AMC falls despite Minions, Rise of Gru breaking the previous July 4th weekend box office record last weekend, grossing $125.2 million in the US, surpassing the previous record set by Transformers, Dark Side of the Moon in 2011. Combine that with the success of the new Top Gun movie, and theaters seem to have had a pretty good run in June and July.

So what’s the problem? ok The minions is only one movie and AMC needs a longer run to get it back on the green. AMC has yet to have a profitable quarter since emerging from the pandemic and is still heavily indebted, with $5.5 billion in debt against $1.2 billion in cash. The company also burned through $330 million in cash in the first quarter, giving it just four-quarters of the way through. Although the second and third quarters should be better given the success of the Top Gun and The minions, will it be enough to get you back to positive cash flow? With cheaper streaming options at home, the recession won’t help.

The same goes for shares of Norwegian and Carnival cruise lines. Although there is huge pent-up demand for travel, these two companies now have to deal with higher fuel and interest rates. But oil prices and long-term interest rates have been falling since the Federal Reserve raised rates by 75 basis points in mid-June, so what’s going on?

Falling oil and interest rates signal cooling demand and potentially a recession. Meanwhile, all cruise lines need to achieve high load factors to return to profitability and pay off their interest costs. Cruise lines are not registered in the US and therefore received less government aid during the pandemic. So both Norwegian and Carnival had to take on lots and lots of debt to survive.

Last month, an analyst in Morgan Stanley announced that Carnival’s debt appeared to be “unbearably high.” Carnival, meanwhile, still posted a $1.9 billion pretax loss in the most recent quarter alone. Norwegian had a pretax loss of nearly $1 billion. Even if they return to profitability this year, it will take a lot of time and effort to pay off their higher debt.

Of course, results should improve for each company compared to the first quarter, as omicron fears were still a concern at the start of the year. However, with recession fears in the air amid Fed tightening, the promise of a sharp recovery in demand is now in question. This doesn’t just mean less than stellar results; these companies must high demand, perhaps just to survive.

Now what

There is currently a high degree of uncertainty about the path of inflation and the economy. While it is still possible for the Fed to create a “soft landing” where inflation cools without the economy falling into a bad recession, it is highly uncertain. Also note that each of these companies has significant European business and Europe is in even worse shape than the US

Given the high uncertainty, investors should probably look to companies with much better balance sheets and less discretionary exposures. No doubt, if things pick up, these stocks could come roaring back; however, there is also the very real possibility that these companies will go bankrupt or at least dilute shareholders even more. With so many high-quality companies declining significantly in this market, these three don’t seem to be worth the risk.

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