Carnival's (CCL 3.57%) low stock price and strong brand make it look like a solid way for investors to bet on a rebound in the tourism industry. Previously, I argued that a rapid restart in cruise operations could bring the company back in the third quarter. But new developments in the coronavirus pandemic have made the stock significantly riskier in the near term. The spike in new COVID-19 cases is drastically worsening Carnival's risk-to-reward proposition.
Here are two reasons to proceed with caution.
Image source: Getty Images.
Coronavirus is resurging
COVID-19 infections are resurging in the United States, leading some states to roll back their reopening plans and place restrictions on some high-risk businesses like bars and restaurants. This is terrible news for Carnival as it looks to resume operations and start making money again.
On April 15, the CDC renewed its no-sail order, extending the prohibition on cruise ships by 100 days. The restrictions are set to expire on July 24. But with COVID-19 infections rising, the CDC will likely extend their restrictions for an additional 100 days -- meaning the order would now expire on Nov. 1.
Carnival could also face restrictions from other countries that may be reluctant to open their ports to vessels from the U.S. given its high rate of infections.
Carnival's management has extended its operational pause through Sept. 30 in light of these challenges. This is the third time the company has pushed back its restart date, but it still may be too optimistic.
Carnival's debt load is alarming
Carnival's management is confident about the company's ability to avoid bankruptcy. According to CEO Arnold Donald, Carnival can survive 2020 without cruise revenue. But with sailing restrictions potentially lasting until the fourth quarter, the company will be cutting it close.
To ensure liquidity, Carnival has piled on a large amount of debt that could hurt shareholder value through expensive interest payments.
In a preliminary second-quarter report published on June 18, Carnival reported $7.6 billion in available liquidity on its balance sheet. This sum won't last very long at current rates of cash burn because the company expects a net loss of $4.4 billion in the second quarter. It will probably report a similar loss in the third quarter as operations are paused through Sept. 30.
To shore up liquidity, Carnival has priced an additional first-priority secured term loan facility with some pretty steep terms.
The debt consists of a $1.86 billion tranche and an 800 million euro tranche ($898.5 million). The interest payments are a flat rate of 7.5% in addition to a variable rate based on Libor, an average of interbank interest rates. The company's cost of capital could become even more expensive in the future because S&P and Moody's both downgraded its credit rating to junk status in June (BBB- and Ba1, respectively).
Takeaway
Carnival stock has become significantly riskier because of the resurgence of the coronavirus pandemic. With infections rising in the U.S., management has pushed back their timeline for restarting operations, and American health authorities are more likely to extend their no-sail-order past July 24.
Investors should think twice about buying shares of Carnival in this uncertain economic environment.
