Carnival: Why The Recent Share Price Low Makes Sense

Thankfully, if slowly, the world is returning to normal after the novel coronavirus pandemic. Yet that trend has done absolutely nothing for Carnival Corporation (NYSE:CCL) stock.

A disappointing fiscal third-quarter earnings report led to a 22% plunge in the shares during trading on Friday afternoon, and it closed on Monday at a 29-year low before finally posting a rally the following day.

From a distance, that weak trading might seem to present an opportunity. After all, presumably at some point normalcy will return in full, and the cruise industry will get back to pre-pandemic levels. Given that Carnival ended 2019 above $50—and peaked at $70 less than two years before that—a price below $8 on its face seems attractive to long-term investors.

The problem, however, is that the valuation on Carnival’s business as a whole actually is much closer to pre-pandemic levels than the CCL stock price would suggest. And in this suddenly very different environment, there are good reasons why that valuation should be lower than it was three years ago. It may not seem like it, but the market probably has CCL pegged correctly.

Explaining The Plunge in Carnival Stock/h2

At the end of 2019, Carnival had 688 million shares outstanding. A year-end share price of $50.24 implied a stories about a cruise ship becoming “a floating prison”—no doubt turned some potential passengers off cruising for good. The global macroeconomic outlook is much bleaker. The strong dollar adds some pressure. Fuel prices are higher (and may well stay that way).

And for the equity, the size of Carnival’s debt is a real concern. The company expects interest expense on its debt alone to total $1.6 billion this year. That’s in the range of 12% of this year’s revenue—and 6%-7% of next year’s revenue, when Carnival’s operations should be back in full swing.

There’s a real risk that Carnival winds up in bankruptcy at some point, as evidenced by the 14%-16% yields on the company’s unsecured debt.

The Long-Term Case/h2

That said, for those bullish on Carnival and on the industry, there is a high-risk case here. The company’s debt cuts both ways.

Assume, for instance, that at some point Carnival’s enterprise value can get back to the $46 billion seen before the pandemic. That expansion alone would lead CCL stock to more than double; assuming the company could pay down some debt along the way (as it plans to do beginning next year), the equity has even more upside.

Near-term results should be strong, given pent-up demand and the end of heightened protocols on board. Indeed, Carnival plans to raise prices next year, after spending most of 2021 and 2022 simply getting the fleet and crews back on track.

So the business should look better next year. Some investors might believe the long-term outlook is solid as well, with Carnival at least capable of getting back to where it was at the end of 2019. Both perspectives can underpin a bullish positioning toward CCL at the moment. But short-term or long-term, this remains a high-risk trade.

Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.