Simple math highlights the case for Carnival (NYSE:CCL, NYSE:CUK). CCL stock is down 70% so far in 2020. What would happen if the stock could recapture those losses?
Well, shares would gain about 230%. If it takes a full decade, shares rally an impressive 13% annually for those ten years. Even if it takes 20 years, shareholders still garner an annualized return over 6%. At a time when 10-year Treasury bonds are yielding one-tenth as much, Carnival in that scenario still would be a good investment.
Put simply, CCL stock seems like one of the most attractive “return to normalcy” plays for patient investors.
But the story isn’t that simple. And, particularly from a short-term standpoint, I’m skeptical Carnival is attractive enough. Even if this case plays out — which is far from guaranteed — it’s going to take some time before shares start to move.
Near-Term Problems
One of the core short-term problems for Carnival is that the company continues to burn an enormous amount of cash. According to the company’s second-quarter report, free cash flow in the first half of fiscal 2020 (ending November) was a loss of over $3 billion.
That figure, incredibly, will get worse in the second half. Carnival expects to burn about $650 million per month. Ship expenses alone, according to the second quarter earnings call, account for roughly $250 million of that rate.
This colors the case for CCL stock. The company came into 2020 with a market capitalization around $38 billion. It’s going to burn in the range of $7 billion this year, which itself suggests a nearly 20% haircut to the stock price.
That’s not the only issue. To fund that burn, Carnival has raised significant debt at significant rates. Most notably, the company in April sold $4 billion in debt at a whopping 11.5% interest rate. Smaller issues have had similar rates.
Thanks to new debt, Carnival’s interest expense is set to rise by roughly $1 billion annually going forward. The company has issued stock as well. Both responses to the crisis suggest a large impact to earnings per share that doesn’t end when this pandemic does.
Lack of a Catalyst
To be fair, the combination of higher interest and a higher share count doesn’t mean Carnival’s stock is going to top out at $15 forever. There’s still a case that a smaller, leaner fleet can return to profitability as demand returns. And that in turn could move the stock higher.
But when, exactly, does that happen? Right now, it doesn’t seem like any time soon. The Centers for Disease Control and Prevention (CDC) has extended its no-sail order through September. With cases rising in Florida, in particular, U.S. sailings seem unlikely before at least 2021.
Even that may be optimistic. And until there’s at least some certainty about a return to operations, it’s hard to see how CCL stock can see a sustainable rally.
The Case for CCL Stock
Certainly, it’s possible that the stock finds a rally at some point. Its shares have fallen further than other novel coronavirus pandemic victims like United Airlines (NASDAQ:UAL) and even fellow cruise play Royal Caribbean Cruises (NYSE:RCL). That suggests — though it doesn’t guarantee — there’s more upside for CCL stock once the industry normalizes.
Progress on a vaccine or a treatment could drive optimism, and Moderna (NASDAQ:MRNA) seems to be heading in the right direction.
Again, I’m sympathetic to the bull case here. But investors need to understand the entire story. Near-term losses are substantial. There’s a catalyst problem as well.
And, as I’ve written before, I still wonder whether consumer behavior has changed for good when it comes to cruises. It’s not just a matter of this crisis. What happens when the next virus spreads — even if its impact is far less severe? What will the headlines be if there’s even an e. coli outbreak on a cruise ship in 2021 or 2023?
Even investors bullish on Carnival’s stock have to acknowledge that there are very real risks. And while those risks might be worth taking, I’m skeptical they’re worth taking just yet.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. As of this writing, Matt did not hold a position in any of the aforementioned securities.
