Why AMC Entertainment, Carnival and Norwegian Cruise Lines Dropped Today

what happened

Shares of AMC Entertainment (AMC 1.24%), Carnival (CCL -3.43%)AND Norwegian Cruise Lines (NCLH -2.37%) fell again on Wednesday after a difficult month in June, down 3.3%, 6.3% and 9.9%, respectively, as of 1:00 PM ET.

There was no material 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 inflation for food and fuel. Second, each of these companies had to incur debt during the pandemic. Not only do they now have the added burden of interest expense, but with interest rates now higher, any refinancing would be expensive.

With the Federal Reserve now signaling its primary goal is to lower inflation, not avert a recession, heightened fears of a recession are destroying these stocks.

And what

It’s worth noting that AMC is down regardless Minions, Rise of Gru breaking the previous July 4th weekend box office record last weekend, grossing $125.2 million in the US which surpassed the previous record set by Transformers, Dark of the Moon in 2011. Combine that with the success of the new Top gun theaters and cinemas seem to have had a pretty good run in June and July.

So what’s the problem? Well, Minions it’s just one movie, and AMC needs a more consistent movie to get back in the green. AMC has yet to have a profitable quarter coming out of the pandemic and still has a heavy debt load, 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 runway. Although the second and third quarters should be better, given the success of Top gun AND Minions, will it be enough to turn cash flow positive? With lower-cost home streaming options, a recession wouldn’t help.

The same applies to Norwegian and Carnival cruise line reservations. Although there is a 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 fallen 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 must achieve high load factors in order to return to profitability and pay their interest costs. Cruise lines are not registered in the US, and therefore received less government assistance during the pandemic. Therefore, both Norwegian and Carnival had to take on a lot of debt to survive.

Last month, an analyst at Morgan Stanley stated that Carnival’s debt appeared “unsustainably high”. Meanwhile, Carnival still posted a $1.9 billion pretax loss last quarter alone. Norway had a pre-tax 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 loads.

Of course, results should improve for each company compared to the first quarter, as the Omicron scare was still a concern at the start of the year. However, with recession fears in the air amid the Fed’s tightening, the promise of returning demand is now in question. This doesn’t just mean less-than-stellar results; these companies need strong demand, perhaps just to survive.

Now what

There is a high degree of uncertainty right now about the path of inflation and the economy. While it’s still possible that the Fed engineers a “soft taper,” in which inflation cools without the economy going into a bad recession, that’s highly uncertain. Also keep in mind, each of these companies has a 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 exposure. Of course, if things pick up, these stocks could bounce back; however, there is also the very real possibility that these companies will go bankrupt, or at least further dilute shareholders. With so many high-quality companies in sharp decline in this market, these three are not worth the risk.

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