In an era where record easy-money policies saved many companies from going bankrupt during the Covid-19 market crash, there were stocks that not only survived but thrived against all odds.
While the major cruise companies like Carnival Corp. (CCL, Financial) managed to avoid bankruptcy, though, no one can really say they thrived. Business was halted for a while and has been slow to recover, and share prices have continued to flounder near the bottom, a testament to how not even a federal funds rate near zero can fix all the problems of cash-guzzlers with a chronic debt addiction.
Extreme levels of debt even before the pandemic ensured that when no-sail orders were enacted and cruise companies found themselves without income and with ships to maintain, they were in quite the bind, forced to sell ships for scrap and issue additional bonds with 10%-plus interest rates just to stay afloat.
Things finally seem to be looking up for cruise operators as demand continues to recover. In previous months, even as some customers began to return, others stayed away due to Covid-19 precautions. However, on Tuesday, the Centers for Disease Control ended its Covid-19 program for cruise ships, sending a strong signal that public wariness of the pandemic has all but faded away.
With things looking up for cruise operators, could Carnival finally be cruising toward a recovery?
Trying to return to normal
With Carnival’s stock up 7% on Tuesday on the hopes for a recovery, let’s focus on the positives first. Customers are returning, which is bringing some much-needed cash flows back to Carnival and its fellow cruise companies.
In its second quarter of 2022, Carnival reported occupancy of 69%, an improvement from 54% in the prior quarter. Booking volumes for all future sailings were double what they were in the first quarter and marked the highest point since the beginning of the pandemic.
As of the second-quarter earnings report released on June 24, 91% of the company’s fleet capacity was in guest cruise operation. Cash from operations finally turned positive again in April, marking a key milestone.
For the week of March 28 to April 3, the company saw the busiest booking week in its entire history since its founding in 1972.
Revenue per share has recovered from the near-zero levels reached in the second half of 2020 and the first half of 2021, and while earnings per share is still negative, the bottom line is recovering.
Carnival and its peers are pulling out all the stops to try and get customers to return. Fares on 2022 sailings in the Caribbean are 2.5% to 7.5% below where they were in 2019 before the pandemic began, making cruises one of the most cost-effective ways to vacation. Carnival’s rates begin at around $289 per person as of this writing.
In regards to Covid-19 testing, while cruises will still be beholden to the testing requirements of the individual ports and countries they visit, being able to scale back their on-board testing requirements could go a long way toward recovering a true vacation atmosphere.
“This marks the elimination of one of the final major hurdles to a return to a more normal cruising environment,” wrote Citi analyst James Hardiman. “At this stage, it would appear likely that most, if not all, cruise lines would drastically scale back the testing and vaccination requirements on their ships to align more closely with airlines.”
Sharks in the water
Despite the ongoing progress in the return to normal, Wall Street overwhelmingly rates Carnival stock a hold. This is especially notable because Wall Street is notorious for erring on the side of over-bullishness rather than over-bearishness. If Carnival is recovering, why have not we seen a wave of upgrades yet?
The answer mainly has to do with debt. No, Carnival’s not likely to go bankrupt. It still has $7 billion in liquidity on its balance sheet as of the most recent quarter’s end, which should tide it over for a few more quarters. Analysts estimate that 2023 will see a return to profitability for the company, which would come just in time to keep the company solvent.
However, not going bankrupt is far from the only criteria for a financially healthy company. Below is a chart comparing Carnival’s earnings per share to its total debt per share:
We can see that the total debt per share has ballooned to twice pre-pandemic levels. Even if earnings per share were to return to pre-pandemic levels, shareholders would be left with twice as much debt per share as before. Not only that, but the share count has nearly doubled since the end of 2019, further diluting shareholder value. Interest expense has multiplied by seven-fold from May 2019 levels to $370 million in the three months ended in May.
There are also worries that a recession is on the horizon, which could negatively impact travel budgets. While cruises are a lower-cost vacation than many options and can thus sometimes benefit during an economic downturn, a full-blown recession would certainly be bad news.
Valuation
It’s tough to value Carnival at the moment because there is a lot of uncertainty on how the recovery will play out, and whether it will be able to get its unprecedented debt levels under control in a rising interest rate environment.
The GF Value chart rates the stock as modestly undervalued based on the combination of historical valuation ratios, past performance and analysts’ estimates of future results, so if everything goes right for Carnival, it could see a solid recovery in a few years’ time.
For many investors, leaving this stock behind seems a no-brainer because there are much better risk-reward scenarios out there due to the general market correction.
Takeaway
With the further easing of Covid-19 precautions, Carnival will be able to take another small step on the road to recovery, but it will likely be far from smooth sailing from here.
The stock is undervalued for good reasons. Before a more bullish outlook can emerge for the stock, Carnival will need to make significant progress on its profitability and debt reduction, both of which are tall orders for such a capital-intensive business.
