Many travel stocks got a big boost earlier this month, as not one but two COVID-19 vaccines showed 95% effectiveness in late clinical trials. Cruise stocks have been among the favorite travel-related stocks in the market. That's likely due to the rabid fandom many cruise lines have garnered as the favored mode of travel in recent years.
The world's largest cruise stock, Carnival (CCL 3.82%) (CUK 3.84%), is one of those that got a boost, rising about 35% on the news. Still Carnival's shares have retreated somewhat since, and are still far, far below the levels it traded at before the pandemic. But does that make Carnival a buy on new reopening hopes? Before you hop aboard, there are three big reasons to hold off on buying Carnival, especially after its recent surge.
A giant pile of debt
In order to make its way through the no-sail period, Carnival has had to sell shares at low prices and issue a mountain of debt. As of the end of its last quarter ended Aug. 31, Carnival had a whopping $24.9 billion in debt on its balance sheet against $8.2 billion in cash. Carnival expects to burn through about $530 million per month in the fourth quarter, even with two of its smaller cruise lines starting back up in Europe.
A higher debt load increases interest expense relative to last year, meaning net earnings will go down, even when things get back to "normal." That debt load will also make up more of Carnival's enterprise value, which is calculated as a company's equity value plus its debt, minus cash. So even if Carnival makes back some of its prior enterprise value, the value of its equity won't go up in tandem. Finally, a higher debt load means that the equity of a company becomes riskier. As Carnival already had a rather high debt load going into the crisis, it doesn't leave much room for error when things get back to "normal."
Whenever the stock goes up, Carnival sells shares
Management has, probably intelligently, also taken advantage of the recent bump in the stock price to sell more shares and raise money. Carnival sold about $1.5 billion of stock after the November bump, on top of a previous $1 billion equity sale less than two weeks earlier. Some will go toward enhancing the company's liquidity position. That's needed because Carnival's U.S. cruises have been delayed yet again amid rising U.S. COVID-19 cases and stringent resail guidelines issued by the CDC. Other proceeds will go toward paying down $500 million of previously issued 5.75% convertible debt.
Still, that debt paydown is a small amount of Carnival's overall debt burden. As such, prospective investors have a quandary: If Carnival's stock price rises by any material amount from here, management is likely to sell more shares to pay down debt, diluting shareholders further and likely sending the stock price back down. Therefore, it's difficult to imagine material gains in the near term, now that the vaccine news is behind us.
Carnival will have fewer ships sailing once cruising resumes
Aside from issuing debt and equity, Carnival has also sold 18 of its less-efficient ships this year in an effort to lower its costs by more than its revenue. While trimming less-efficient ships will likely increase Carnival's margins, it will probably lower its overall revenue and profit outlook in absolute dollar terms.
That means when things get back to "normal," so to speak, Carnival will probably make less in operating income, at least to start. Operating income combined with even higher interest expense will mean less and less net profits with which to chip away at the aforementioned mountain of debt.
Carnival has done an admirable job of keeping the lights on and coping with the pandemic environment. However, just because the company is doing as well as it can doesn't mean it's a great buy at the current price. I do own a small bit of Carnival stock (from lower levels), but at around $18, it looks as though a lot of good outcomes from the vaccine are priced in.