The cruise industry came under pressure earlier this year as global travel and leisure activities came to a standstill. The stock prices of the major players of this industry, including Carnival Corporation & Plc. (CCL, Financial), Royal Caribbean Group (RCL, Financial) and Norwegian Cruise Line Holdings Ltd. (NCLH, Financial), plummeted in the first quarter as the unpleasant reality facing the sector was absorbed by the market.
The Centers for Disease Control and Prevention issued a No Sail Order for cruise ships effective March 14, which was extended on April 9, July 16 and Sept. 30. These continued extensions prevented cruise ships from sailing once again, and the outlook remained uncertain.
In a breakthrough announcement on Oct. 30, the CDC issued a framework for a Conditional Sailing Order, immediately improving the market sentiment and resulting in a 5% move up in the Carnival stock price. In the 40-page Order, the CDC wrote:
"After expiration of CDC's No Sail Order on October 31, CDC will take a phased approach to resuming cruise ship passenger operations in U.S. waters. The initial phase will consist of testing and additional safeguards for crew members. CDC will ensure cruise ship operators have adequate health and safety protections for crew members while these cruise ship operators build the laboratory capacity needed to test future passengers."
According to the CDC, the next phase will include simulated voyages to test the ability of cruise operators to adhere to precautionary measures to prevent the spread of the pandemic. Many uncertainties need to be addressed, but this latest development paints an optimistic view of what the future holds for Carnival as the leader of this lucrative industry.
After a careful analysis of its unique liquidity position and the macroeconomic outlook, I predict that investing in Carnival stock could deliver multi-bagger returns in the next decade, despite the company's incredibly high amounts of debt issued at sky-high interest rates.
The timeline
Carnival stock popped more than 5% on Oct. 30 as investors took the new development in stride. This early positive reaction, however, does not mean that ships would sail anytime soon. In fact, Wall Street analysts believe that February is the likeliest month in which business will resume. In a research note to clients, UBS analyst Robyn Farley wrote:
"Bottom line is that cruise lines will not be able to offer passenger cruises in December, but January seems possible, though February more likely, in line with what the CDC was reportedly already targeting. That leaves downside risk to our Q1 estimates, which had assumed 7% of cruise capacity in use, but wouldn't have as much negative impact on our 2H estimates. Overall, our 2021 estimates assume about 30% of cruise capacity in service for the year on average, so some downside risk to that from 1H adjustments but a Feb restart would at least give higher conviction in 2H and forward."
Even though some investors believed Carnival would be able to pull off a resumption of business activities before the end of this year, the company issued a press release on Nov. 2 announcing the suspension of North American cruises until Dec. 31. Carnival CEO Arnold Donald wrote:
"We continue to work with the U.S. Centers for Disease Control and Prevention, and global government and public health authorities, as well as top medical and science experts around the globe, on a comprehensive plan for the eventual restart of cruising in North America."
There is reason to be excited, but investors should keep their enthusiasm in check because Carnival would be forced to invest millions of dollars to adhere to preventive measures introduced by health authorities. The expected losses in the fiscal fourth quarter might lead to a pullback in the stock price, which needs to be considered before betting on the company's recovery.
The liquidity position holds the key
Surviving an extensive zero-revenue environment has become the key challenge to all players operating in the cruise industry, especially since many of them went into the pandemic already strapped for cash. Back in May, Carnival executives suggested $300 million per month in operating costs to keep its ships in proper shape. Using this as an assumption, the below table illustrates the expected cash burn of the company if Carnival generates zero revenues through the end of July 2021.
| Item | Amount |
| Operating costs | $2.4 billion ($300 million per month for eight months) |
| Debt repayments | $2 billion |
| Interest payments | $500 million |
| Refunds | $3.29 billion (assuming 70% of bookings will have to be refunded) |
| Total cash burn | $8.2 billion |
| Total liquidity as of Aug. 31 | $8.2 billion |
Source: Company filings
The cruise industry is likely to resume business by February, which makes the assumptions in the above table highly conservative. Even in the worst-case scenario, Carnival should still be able to survive without raising additional funds. In the base case scenario, the company would be in a strong position to resume its growth story by mid-2021, which would lead to a surge in its market value.
Looking at popular valuation metrics such as price-earnings ratios and free cash flow growth will fail to provide meaningful insights into Carnival and other cruise companies as all these numbers have turned negative this year, which is a temporary phenomenon that I think is highly unlikely to be repeated in the foreseeable future once normal operations resume. Therefore, it's imperative to base the analysis on the current liquidity position and future expected earnings to gauge a measure of the true economic value of Carnival.
Surviving until normalcy prevails is the key to a cruise company's success at the moment, and according to my analysis, Carnival has what it takes to remain solvent until business conditions improve.
Mr. Market will reward Carnival ahead of an improvement in numbers
The stock market is supposed to be forward-looking, meaning that price actions today reflect the expected changes in the future and does not mirror what has already happened. Going by this assumption, one should expect Carnival to stage a comeback in the market before its numbers improve meaningfully. For this reason, staying on the sidelines until the company reports solid numbers is not a prudent strategy. The best time to invest in Carnival is when there is fear in the market, and right now, there's a lot of fear.
Takeaway
In my opinion, investing in Carnival stock should be considered by growth investors with an above-average risk appetite, as many things could go wrong despite the promising developments. The uncertainty is here to stay for many months to come, and investors who are considering Carnival should brace themselves for a bumpy ride.
However, there is light at the end of the tunnel. The difficult business conditions will not last forever, and Carnival has what it takes to survive many more months with zero revenues. The company is likely to report above-average revenue growth toward the latter half of 2021, and pre-bookings could reach record highs by the end of the next year as demand kicks in once again. The stock is still trading 70% below the prices seen in January, which is a clear indication of the pessimistic sentiment in the market. This creates an opportunity for contrarian investors.
Disclosure: I own shares of Carnival Corporation.
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