Carnival: Why The Recent Share Price Low Makes Sense
2022.10.05 10:35
- Down 84% year to date, Carnival stock seems left out of ‘return to normalcy’ trade
- Equity and debt issuance to fund pandemic losses explains much of the decline
- Long-term investors can still be bullish on the stock, but it’s a risky play
Thankfully, if slowly, the world is returning to normal after the novel coronavirus pandemic. Yet that trend has done absolutely nothing for Carnival Corporation (NYSE:) stock.
A disappointing fiscal third-quarter report led to a 22% plunge in the shares during trading on Friday afternoon, and it closed on Monday at a 29-year low before finally posting a rally the following day.
From a distance, that weak trading might seem to present an opportunity. After all, presumably at some point normalcy will return in full, and the cruise industry will get back to pre-pandemic levels. Given that Carnival ended 2019 above $50—and peaked at $70 less than two years before that—a price below $8 on its face seems attractive to long-term investors.
The problem, however, is that the valuation on Carnival’s business as a whole actually is much closer to pre-pandemic levels than the CCL stock price would suggest. And in this suddenly very different environment, there are good reasons why that valuation should be lower than it was three years ago. It may not seem like it, but the market probably has CCL pegged correctly.
Explaining The Plunge in Carnival Stock
At the end of 2019, Carnival had 688 million shares outstanding. A year-end share price of $50.24 implied a market capitalization just shy of $35 billion. With $11 billion in debt net of cash, Carnival’s enterprise value—essentially, the valuation implied by both the equity and debt underlying the business — at the time was about $46 billion.
Again, 34 months later Carnival stock has declined 84%. But Carnival’s enterprise value has not fallen that far—or anywhere close to it.
After all, the pandemic created enormous losses for Carnival. Over the past eleven quarters, the company’s free cash flow has been negative $23 billion. To fund that burn, Carnival has issued both equity and debt.
The equity offerings have increased Carnival’s share count by more than 60%, to 1.113 billion. Debt net of cash has ballooned from $11 billion to $27 billion. At Tuesday’s close of $7.76, Carnival stock is down 84% since the beginning of 2020—but over that period its enterprise value has declined just $10 billion, or 22%.
A Lower Valuation For Carnival
A decline of that size makes some sense. This probably should be a less valuable business than it was three years ago.
After all, the pandemic—and the stories about a cruise ship becoming “a floating prison”—no doubt turned some potential passengers off cruising for good. The global macroeconomic outlook is much bleaker. The strong adds some pressure. Fuel prices are higher (and may well stay that way).
And for the equity, the size of Carnival’s debt is a real concern. The company expects interest expense on its debt alone to total $1.6 billion this year. That’s in the range of 12% of this year’s revenue—and 6%-7% of next year’s revenue, when Carnival’s operations should be back in full swing.
There’s a real risk that Carnival winds up in bankruptcy at some point, as evidenced by the 14%-16% yields on the company’s unsecured debt.
The Long-Term Case
That said, for those bullish on Carnival and on the industry, there is a high-risk case here. The company’s debt cuts both ways.
Assume, for instance, that at some point Carnival’s enterprise value can get back to the $46 billion seen before the pandemic. That expansion alone would lead CCL stock to more than double; assuming the company could pay down some debt along the way (as it plans to do beginning next year), the equity has even more upside.
Near-term results should be strong, given pent-up demand and the end of heightened protocols on board. Indeed, Carnival plans to raise prices next year, after spending most of 2021 and 2022 simply getting the fleet and crews back on track.
So the business should look better next year. Some investors might believe the long-term outlook is solid as well, with Carnival at least capable of getting back to where it was at the end of 2019. Both perspectives can underpin a bullish positioning toward CCL at the moment. But short-term or long-term, this remains a high-risk trade.
Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.
