Carnival Corporation Seems To Be Trading Ahead of Fundamentals

With vaccinations providing much needed hope in the fight against the COVID-19 pandemic, travel and tourism stocks have surged.

Among cruise stocks, Carnival Corporation (CCL) has gained 75% in the last six months and has out-performed industry peers like Royal Caribbean (RCL) and Norwegian Cruise Line Holdings (NCLH).

However, it seems that CCL stock is now trading ahead of its fundamentals. Taking into account the possibility of an industry recovery coupled with the health of the company’s balance sheet, a correction in price seems imminent.

As the company shrinks its fleet due to the pandemic, CCL’s CEO has opined that a full recovery is unlikely before 2023. If this holds true, the company has another 12-18 months of relatively challenging conditions to address.

Meanwhile, Jason Ader, CEO of SpringOwl Asset Management, is even more bearish and believes that peak profitability in the cruise industry is unlikely before 2030.

With this overview, let’s consider the credit stress that Carnival Corporation is likely to face.

Balance Sheet Concerns For Carnival Corporation

In terms of positives, Carnival Corporation reported $9.5 billion in cash and equivalents as of November 2020. With cash burn likely to continue in the near term, the liquidity buffer will support the company’s operations in the coming quarters.

However, there are plenty of concerns from a credit perspective.

As of November 2020, the company reported total debt of $26.9 billion. This resulted in the company’s interest expense (net of capitalized interest), swelling to $895 million for FY2020. Carnival Corporation will be servicing debt through additional debt.

Survival is not a concern. However, CCL will focus on de-leveraging as it navigates its way through the crisis period, which means that value creation for shareholders is unlikely in the near-term.

It’s worth noting that for FY2020, the company reported cash used in operations of $6.3 billion. With a “U-shaped” industry recovery likely, operating cash flows are expected to remain negative throughout the year.

Considering the cash burn rate, Carnival Corporation reported monthly cash burn of $500 million for Q4 2020. For Q1 2021, the monthly cash burn is expected at $600 million which as a ball-park estimate for the year, would imply annual cash burn of $7.2 billion.

It’s not surprising that the company pursued further equity dilution in February 2021, but if an industry recovery remains sluggish in 2022, additional dilution could imply downside risk for CCL stock.

Carnival Remains Interesting For The Long-Term

CCL’s current valuation might look stretched considering the company’s balance sheet stress, however, if industry profitability can return to peak levels in 2023, there is a strong case for accumulating the stock on any meaningful correction.

The decision by Carnival Corporation to dispose of 19 ships looks like a good one. These ships accounted for 13% of the total capacity, but only 3% of operating income in FY2019. The sale of less efficient ships will have a positive impact on its cost cutting initiatives.

From a de-leveraging perspective, Carnival Corporation reported operating cash flows of $5.3 billion in FY2019. Assuming that peak profitability returns in FY2023, the company will be well-positioned to de-leverage over the next few years.

Wall Street Weighs In

Consensus among Wall Street analysts is a Hold based on 4 Buy,  Hold, and 4 Sell recommendations. The average analyst price target of $24.33 implies downside potential of approximately 17% from current levels over the next 12 months. (See Carnival stock analysis on TipRanks)

Concluding Thoughts

The very fact that Carnival stock out-performed its peers in the last six months is an indication of the company’s relative strength.

However, it seems that the stock has already priced-in the positive potential outcomes so adding exposure to the stock at current levels might not make sense.

Value investors would likely prefer to wait for a correction and further confirmation on the possible timing of the industry recovery before accumulating more CCL stock.

Disclosure: On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.