A Look Into Carnival
Disclaimer: This is not investment advice, just one person’s opinion. Always complete thorough analysis on your own before investing and understand the risks associated with an investment as you could lose it all.
Since the March lows we have hit new highs in the S&P500, mostly led by technology and companies that have been less affected by Covid. However travel and leisure stocks remain largely unliked by investors. This poses the question, when will cyclical stocks start gaining steam? I wish I knew the answer, but I honestly don’t know. What would be an interesting exercise is to try and understand specifically why these stocks are trading where they are.
The answer is obvious: Covid. But what earnings expectations, what re-oppening plan, and what liquidity profile is the market pricing in for these stocks? Now these questions are ones that I can attempt to answer. To answer these questions I will use Carnival Cruises as an example.
Before we can look at these questions, we must understand some background about Carnival. Carnival is a cruise company that earned $20 billion in fiscal year 2019, but back then its stock was trading at around $50. In the second quarter Carnival only earned $740 million in revenue and its stock has been trading around $15.
Obviously cruises are one of the most Covid affected industries. Unlike travel, you are in close proximity with others, for leisure. Because of this, Carnival and other cruise companies are expecting low to zero revenue in the third quarter, and potentially the fourth. To remedy this, Carnival specifically has used the capital markets to its advantage. Since March Carnival has repeatedly issued debt and stock in order to maximize its cash position. In this time period, Carnival has issued equity twice and issued debt five times.
To create this analysis, I began by importing balance sheet and
In order to determine how long this new financing will last, I will look at Carnival’s liquidity as of today. I define liquidity as how much cash Carnival has left to spend after repaying necessary obligations like debt. Since Carnival’s most recent financial report released in April, Carnival has $7.6 billion in liquidity. This comes from revolver drawdowns of $3 billion, $220 million from gains on derivatives, $4 billion issuing bonds, $2 billion issuing convertible bonds and $575 million in equity issuance. After subtracting cash burn, commercial paper, and other costs of $2.2 billion, you get to $7.6 billion. Since that financial statement, Carnival has made additional transactions and has burned considerable cash.
Carnival issued $2.8 billion in loans, $1.2 billion in bonds and Carnival issued $1.3 billion in stock to repurchase the same amount in convertible bonds. To date, Carnival has burnt through $1.5 billion in cash. In addition, Carnival will spend $2.4 billion on repaying debt in the next year, so we will subtract that amount from Carnival’s liquidity. Finally, on the 10th Carnival raised $900 million in debt. So as of today, Carnival has $8.5 billion of liquidity.
Based on management’s projections, Carnival will burn $650 million per month. This means Carnival has enough cash to last between 12 and 13 months with no revenue. If Carnival must refund customers for Q3 and Q4 sailing, they will have 12 months of liquidity. This means that if Carnival earned no revenue for a whole year, they could continue operations without having to sell assets or without another visit to the capital markets.
If you think Carnival can be profitable within a year then the stock is likely undervalued. Considering it is trading at a 70% discount to its pre-covid levels, it could be a bargain if you expect a quick return to profitability. According to management, Carnival is profitable on a cash flow basis if 25-30% of their fleet is being utilized. If you think Carnival can reach and maintain this level within a year, again the stock is likely a bargain.
I do not see it as a bargain yet because Carnival received the revenue for many of its 2020 bookings and some of its 2021 bookings in advance, if there are issues sailing they will have to refund customers. In addition, Carnival will likely offer discounts to get people to cruise, and this means that more than 30% of capacity will need to be utilized. Can they do this with social distancing?
I will attempt to find out in my next article where I will explore a scenario analysis of Carnival to see if they will have enough cash flow to stay afloat.
