Carnival: Enormous Risk For LT Common Stockholders

Summary

• Carnival has several improving metrics as COVID-19 wanes, which may make the stock tempting to investors.
• However, the company has taken on so much debt and issued so many shares that there will be nothing left on the bones for long-term common shareholders.
• Just how bad is it? It's bad. Let's take a look.

SeregaSibTravel/iStock Editorial via Getty Images

Introduction:

I rarely publish "sell" opinions. After all, how do I know the reader's situation? Is the stock 50% of their portfolio, or just 0.5%? Are they 20 years old with 50 years left to invest, or 75 and retired? What is their basis and tax situation? All of these make a difference.

But sometimes, a company appears so damaged that a sell opinion is compelling. The last time I wrote a staunchly bearish article was here about The RealReal (REAL). Since publication, The RealReal is down over 88%, as shown below.

Data by YCharts

In the case of Carnival Corporation (NYSE:CCL), the risk/reward ratio is heavily skewed to the downside for the long-term common shareholder, and the opportunity cost is high.

Stock traders and short-term investors may do well with Carnival.

The company is prone to multi-percentage swings on goods news and bad. The improving income statement can also cause investors to overlook the leverage-bursting balance sheet in the short term. In addition, the stock price appears to be a bargain compared to the trading price before the pandemic. Unfortunately, it is not, and long-term investors have little to look forward to.

Reasons For Optimism

Carnival's Q1 fiscal 2022 earnings release contained some encouraging metrics. 75% of capacity is again sailing and ready to receive guests. By the summer, the company expects to be EBITDA positive.

Revenue hit its highest point since the Spring of 2020, and sales per passenger cruise day (PCD) were up more than 7%. However, much of this was offset by higher expenses and likely a result of inflation. Bookings increased, and customer deposits reached $3.7 billion.

Revenue has steadily increased recently, but the net loss hasn't changed much.

Data by YCharts

The relatively positive news has caused some investors and authors to turn bullish on the company. But we need to take a look under the hood first.

Just How Bad Is The Debt?

Carnival reported $34.9 billion in long-term debt (including the current portion) and short-term borrowing in its most recent quarterly earnings. The debt skyrocketed during the pandemic for obvious reasons and has continued to grow every quarter since.

Data by YCharts

This number isn't meaningful until we add context.

In the prior full eight years before COVID-19, Carnival produced total cash from operations (CFO) of $35.3 billion - combined. As shown below, it would take nearly every dollar produced from operations over eight years to swallow the debt.

Data source: Seeking Alpha. Chart by author.

Unfortunately, even that does not tell the whole story. A company like Carnival has large capital expenditures (CAPEX) to keep the fleet in working order and competitive.

When CAPEX is subtracted from CFO, the already bleak picture is much more severe, as shown below.

Data source: Seeking Alpha. Chart by author.

Carnival currently has $16.9 billion in CAPEX commitments forecast through 2025.

Sales have increased recently, but this has come at a cost. Carnival continues to lose money from operations. In fact, last quarter's increased revenue led to a steeper cash outflow from operations.

Data by YCharts

Because of this, Carnival will have no choice but to refinance the debt as it becomes due. This is a serious problem in a rising interest rate environment. Indeed, the process has already begun. The company has refinanced some 2023 maturities out to 2030. These notes pay interest semi-annually at a rate of 10.5% per year. What does this mean? It means that besides paying a large interest expense, Carnival's bonds are deep into "junk bond" territory.

Pushing these notes out to 2030 may keep the company in business and satisfy debt holders who are receiving an astronomical rate of return, but common stock shareholders are last in line.

Is The Valuation As Compelling As It Looks?

Carnival's share price has lost 68% of its value since before the pandemic.

Data by YCharts

This can make it seem like a good deal as the company begins to generate sales once again. However, the company issued so many shares, and the debt increased so much, that the enterprise value is actually 6% higher now than it was before the pandemic.

Data by YCharts

In other words, investors are paying more now than they were before the pandemic even though the stock price per share is lower. It is like going to the store and seeing that your favorite product is less expensive, and then realizing there is much less in the package and the per-unit price is actually higher.

Anything else?

Unmentioned above is the near-term risk that inflation and a potential recession could materially negatively impact the travel industry as a whole, and cruise lines in particular, and inflate costs such as fuel and wages. A resurgence in COVID-19 would also be devastating.

The Bottom Line

Remember that in any bankruptcy reorganization, the debt-holders have priority over common stockholders. Common stockholders are often wiped out completely. The Altman Z-score is a credit strength metric that gauges the likelihood of a company's bankruptcy. The lower the score, the more danger a company is in, and a score above 3 suggests good financial standing. According to Seeking Alpha, Carnival has a dismal score of just 0.11. For comparison, struggling Peloton (PTON) has a score of 4.79, Alphabet (GOOG)(GOOGL) tops 13, and Intuitive Surgical (ISRG) bests 45. This further illustrates the poor risk/reward for long-term investors.

COVID-19 was the worst possible environment for a cruise line operator, and Carnival was forced to take drastic action to stay afloat. Unfortunately, this has devastated common shareholders. The debt load and increase in the share count have left little reason to hold this company for a long-term investor.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.