Few companies have been battered as hard as Carnival Corporation (NYSE:CCL) by the coronavirus pandemic and resulting lockdowns. Along with hotels and airlines, Carnival has the misfortune of being a travel and leisure company with high overhead and effectively no income for the foreseeable future.
In mid-January, when COVID-19 was hitting the Chinese economy hard but seemed a world away from Europe or the United States, CCL stock traded around $52 per share.
But as the virus spread and investors started to appreciate how quickly the virus had spread, Carnival’s shares went into freefall, dropping all the way to $7.80. At the time of writing, shares were trading at $12.42, 76% below the mid-January levels.
After a drop like that, the bargain hunters start sniffing around. After all, on paper the stock looks cheap, trading at 4.5 times trailing earnings, 0.37 times sales and 0.36 times book value.
Looking at that book value number, you could hypothetically sell off Carnival for spare parts, pay off all its liabilities and still walk away with a substantial profit of over $22 per share.
But resist the urge to run out and buy shares. It might look cheap on paper, but Carnival and its peers among the cruise lines are by no means a safe bet.
Carnival is Debt Heavy
Carnival took on $1.4 billion in new debt in 2018… and effectively used the entire amount to buy back its stock. In 2019, the company borrowed another $1.4 billion, and used $603 million of it to repurchase stock. And now, most recently, the company had to borrow $4 billion at a usurious rate of 11.5%. It also borrowed an additional $1.75 billion in convertible notes.
Carnival also plans on offering about $500 million in common stock.
Let’s play with the numbers. Carnival will pay about $460 million in interest on the new $4 billion notes and $100 billion on the convertibles. This is in addition to the roughly $200 million the company is already paying on existing debt.
In a normal market, Carnival would have no problem meeting those obligations. The company did over $5 billion in earnings before interest, taxes, depreciation and amortization (EBITDA) over each of the last two years.
Of course, this is not a normal market. Carnival has said it burns through about $1 billion per month, and revenues are zero at the moment. So unless cruise ships are back in action by September, Carnival will have exhausted that cash infusion.
The company has other options short of bankruptcy protection. It could raise more equity or find a large institutional investor to bail it out. Saudi Arabia’s sovereign wealth fund just took a major stake in the company and it’s possible others would follow. But additional equity will dilute current shareholders, so that’s not exactly a panacea.
It’s also worth mentioning that other travel and leisure industries — such as airlines — have strong political connections and are considered essential services. Cruise ships are by no reasonable definition essential, and by being domiciled offshore, there is virtually no chance of a government bailout. They’re on their own.
Be Honest… Would You Take a Cruise Right Now?
I’m generally the optimistic sort. I think it’s amazing how quickly companies have adapted to the “new normal” of a lockdown economy. Even struggling restaurants in my native Dallas have managed to keep the lights on by increasingly their carryout options and even selling alcoholic cocktails to go.
Once the lockdowns are lifted, I expect the entertainment and leisure industry to bounce back pretty quickly. I’d kill for a good restaurant meal right now, or to see a movie in a movie theater and not on my living room TV. I’d also love to watch a game at my neighborhood sports bar… or better yet, live in a stadium. I think it’s even possible my kids drag me to Disney’s (NYSE:DIS) Disney World sooner rather than later.
But there is absolutely no way under the sun I’d consider taking a cruise at any point in the next two years. In fact, possibly never. The idea of getting stuck on a boat, in quarantine, for weeks or months… It’s just not happening. I’ll risk picking up the virus at a basketball game, a bar or a movie. But I won’t risk getting stranded on a boat for a month.
Now be honest. Would you take a cruise any time soon? Would your friends or family?
Cruises could be made “safe” by requiring that all passengers take a coronavirus test immediately before embarking. But it would only take one false negative or contaminated food delivery to turn a cruise into another death ship.
I don’t expect the passengers to immediately flock back to the cruise lines, though I do expect the industry to survive. There are plenty of travelers that love taking cruises, and many will eventually return.
At current prices, Carnival’s shares might be cheap enough to justify rolling the dice. But they are by no means a sure thing, and anyone investing today needs to consider the very real possibility of major share dilution. This is an industry that will be on life support for months, possibly even years to come.
Charles Sizemore is the principal of Sizemore Capital Management, a registered investment advisor based in Dallas, Texas. As of this writing, he was long DIS.
