The trajectory the Carnival (LSE: CCL) share price has been down since late 2017. Then came the coronavirus and the market crash that wiped out over 75% of the price of Carnival shares in little over a month. Now that the dust has somewhat settled, those shares are trading at 1,247p, well below their 2017 high of 5,435p. So, is the Carnival share price a bargain?
Debt anchor
Let’s start with that decline in share price before the coronavirus hit the markets. Carnival’s revenues have grown each year from 2015 to 2019. Net income has been a little more volatile, but 2019 net income was higher than it was in 2015. Dividends were also creeping higher. It might seem odd that the share price was declining from 2017, given these trends.
What were investors reacting to, then? Well, cash balances were shrinking, and debt was rising as Carnival increased its cruise capacity. However, industry analysts were forecasting a slump in demand for cruises back in 2017. But perhaps they were jumping the gun. The ratio of Carnival’s sales to its property, plant, and equipment increased from 0.49 to 0.55 between 2016 and 2019. Whatever the increases in capacity, the company was drawing even more in revenue, and confounding analyst expectations.
But then the coronavirus hit. Demand for cruises did not just slump, it capsized. To stop itself going under, Carnival pledged around $28bn of idled cruise ships and other assets as collateral to raise $3bn in three-year bonds. The interest rate on these bonds is a hefty 11.5%, costing $450m in interest each year. In addition, Carnival sold $1.75bn worth of bonds that can convert into shares, as well as $1.25bn worth of new shares.
Cheap cruise?
Cruise companies had already suffered reputational damage from frequent norovirus outbreaks aboard their ships. Covid-19 outbreaks at sea now add to the concerns around staying healthy when cruising, particularly for the roughly one in seven cruise ship passengers that are over 70, who will probably not book a new trip for years.
In time, however, I believe the cruise proposition will regain most of its appeal, and Carnival could, at least operationally, match its previous performance. Before the pandemic struck, Carnival had a 20-quarter streak of beating analyst expectations. It was taking in more revenues and using its assets with increasing efficiency.
The problem is that equity investors will see large interest payments eat into their cash flows, and there are more of them competing for what’s left, even if performance returns to normal. There is a risk that further debt and equity issues could make the situation worse, particularly if it takes longer than expected for the world to return to normal. Then there is always the chance that Carnival will not survive.
I am wary of calling the Carnival share price a bargain. In the short term, those shares look more like a bet on survival, and I would rather own the company’s three-year bonds. In the long term, it will take years to pay down that balance sheet and get earnings and dividends per share back to where they were.
