The past few years have been a rollercoaster ride for companies and investors alike. When the Covid-19 pandemic triggered a market crash in early 2020, the Federal Reserve responded aggressively by slashing interest rates to near zero. Many companies took advantage of ultra-cheap borrowing costs to load up on debt and survive the massive economic disruption. However, much of this debt was issued with floating interest rates, leaving corporations vulnerable when the Fed pivoted to raising rates in 2022. Now, as interest rates peak, companies saddled with floating-rate debt are getting squeezed by spiking interest payments. Their profits and valuations have taken a beating.
Nonetheless, this pain will be temporary for companies with strong underlying businesses. While floating-rate debt felt like free money during the pandemic, high-interest costs are now wreaking havoc on cash flows. Yet, as rates inevitably plateau and retreat, these companies will quickly regain their financial footing. With lower debt expenses, their earnings growth will accelerate rapidly. And as profits rebound, their stock prices should follow suit.
Savvy investors can take advantage of this opportunity by snapping up high-quality companies with lots of floating-rate debt while prices remain depressed. Then, you can enjoy the rewards when their performance bounces back as rates decline. Here are the three stocks I’m watching right now.
Carnival Corporation (CCL)
Carnival Corporation (NYSE:CCL) has endured extreme volatility over the past few years, with its share price declining more than 80% from its 2018 peak. The pandemic dealt a massive blow to the cruise industry, with health concerns and travel restrictions severely hampering demand. Thus, Carnival saw revenues plunge, and was forced to take on substantial debt just to stay afloat.
However, there are signs Carnival may be turning a corner and cruising towards calmer waters. In the latest quarter, Carnival generated revenues of $6.85 billion and earnings per share of $0.86, handily beating Wall Street estimates. Occupancy levels approached historical highs in August across its fleet, while ticket prices soared 7% above 2019 levels. New bookings and customer deposits also hit fresh records.
Critically, Carnival is making solid progress in paying down debt and reducing leverage. While long-term debt is expected to remain elevated at $31 billion, it has come down by more than $4 billion from its peak. Plus, with profits rebounding, Carnival is poised to accelerate debt reduction and restore its financial health. As the lingering impacts of COVID fade further, the company’s cash generation ability should continue improving.
There’s no denying Carnival still faces challenges, with high fuel costs and inflationary pressures biting into margins. However, at a share price languishing around $13, Carnival offers compelling value for investors with a long-term focus. In essence, you can buy CCL stock today for what it traded at in 1996, ignoring the pandemic anomaly. With its core cruising business rebounding strongly, Carnival appears significantly undervalued at current levels. The market may be underestimating its staying power and ability to excel in the post-COVID world. The consensus upside potential with this stock is 47%.
American Airlines (AAL)
American Airlines (NASDAQ:AAL) is another pandemic-battered stock with huge upside potential. This leading airline faced an unprecedented plunge in travel demand, leaving it swimming in red ink. American Airlines burned through a tremendous amount of cash, simply trying to endure until travel picked back up.
Flash forward to today, and American Airlines is flying high once again. The summer travel season witnessed a resurgence in demand, allowing American Airlines to deliver record revenues of $14 billion in the second quarter along with its fifth straight profitable quarter. Domestic bookings remain robust, while international travel leads the recovery.
Just as importantly, American Airlines is acting aggressively to repair its balance sheet. The company reduced total debt by $9.4 billion from its 2021 peak, leaving it with $30.7 billion remaining as of Q2 2023. While still elevated, the company’s debt burden is clearly easing, and American Airlines’ interest coverage metrics are improving substantially. With industry conditions normalizing, profits are rebounding strongly, which should allow management to further accelerate deleveraging.
Obviously, higher fuel costs and lingering economic uncertainty are biting the stock. But with shares trading at only a fraction of their pre-pandemic value, American Airlines looks compelling for investors who believe it has left the worst turbulence behind. Its operations and financials are trending very positively now that travel activity is rebounding healthily. For anyone building a long-term portfolio, American Airlines deserves a close look at today’s discounted levels before the market rewards its recovery. Wall Street believe AAL stock can deliver 40% upside in one year.
AT&T (T)
In contrast to pandemic-induced carnage, the decline at AT&T (NYSE:T) has been more gradual and painful. This telecom giant has suffered from cord-cutting pressuring its video distribution business along with heavy debt burdens from acquisitions gone awry. Its stock has bled consistently lower and now sits 55% below 2016 peaks.
However, for contrarian investors, the negativity looks overdone. Steps to streamline operations and strengthen its financial position. While still a work in progress, AT&T reduced net debt by $20 billion over the past three years to $128 billion (long-term debt). It recently transferred $8 billion of pension obligations to insurance firms to ease this burden. Even amidst massive interest expenses, AT&T generated $4.2 billion of free cash flow in the first half of 2023.
The underlying businesses also look healthier. The company’s mobility unit is performing well, with wireless service revenues up 4.9% last quarter. New fiber locations over the past three years total 7 million, with passed locations up 40%. These fiber customers spend more on average than legacy copper-based ones, providing a higher-margin revenue stream.
Right now, 5G deployments and fiber investments are peaking, portending lower future capital spending. AT&T anticipates using more free cash flow to pay down debt and restore its financial flexibility going forward. Thus, analysts believe the end of the bleeding is near, and the consensus price target implies 38% upside for shares of T stock.
On the date of publication, Omor Ibne Ehsan did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
