The cruise industry has been among the hardest hit during the COVID-19 pandemic, virtually shutting down to prevent passengers from getting sick. Cruise line company Carnival (CCL 2.30%) has resumed operations, but the stock remains well below its pre-COVID share price.
If you're wondering whether Carnival can reclaim its pre-COVID highs anytime soon or whether the stock is a promising long-term investment, there are some things you need to know. Here are three observations about Carnival that could concern investors.
Image Source: Getty Images.
1. Robbing the future to stay alive
Carnival did what it had to during the COVID-19 pandemic, which dealt it a pretty rough hand. Carnival operates expensive cruise ships that require supplies, fuel, and crew to service guests. The ships need to run near full capacity, and profitability plummets if they aren't.
The company did what it could to cut costs, but the reality is that Carnival had to raise a lot of money to survive COVID-19. It did this both with debt and by issuing new shares of stock to raise money. You can see in the chart below how debt has climbed from roughly $12 billion just before the pandemic to more than $33 billion today. Additionally, the number of outstanding shares has increased to 1.1 billion.
CCL Total Long Term Debt (Quarterly) data by YCharts
These actions were necessary but came with a cost to investors. Carnival's increased debt will result in higher interest expenses, which will eat away at Carnival's net income -- its bottom-line profits.
Meanwhile, issuing new shares makes the existing shares worth less by decreasing Carnival's per-share metrics like earnings per share. The dramatic increase in both debt and shares is likely to negatively impact the stock's investment returns.
2. The stock's valuation has already recovered
The stock's heavy debt and additional shares have skewed the stock's valuation, creating an illusion that the stock is cheaper than before the pandemic. While that's true from a share-price perspective, investors should consider its valuation through enterprise value, which is a company's market cap plus its net debt. In other words, what is the market price of a company if you were looking to buy the whole thing?
You can see in the chart below that Carnival's enterprise value was approximately $48 billion in January 2020. The company had fewer shares trading at a higher price and less debt. But now, the additional shares and debt have bloated the stock's valuation, offsetting the declines in the share price.
CCL Enterprise Value data by YCharts
For the company's share price to continue increasing from here, its enterprise value would need to grow beyond its pre-COVID level. That could be tough to justify in the near term because of the uncertain operating environment Carnival currently faces moving forward.
3. The bleeding might not be over yet
The pandemic could soon fade as more people become vaccinated worldwide, and Carnival might begin seeing demand come back for cruises. It plans to resume use of all 10 of its year-round U.S. ports by March and have its entire fleet sailing by May.
Investors will want to see how full these cruises are. Resuming full operations will likely ramp up operating costs in 2022. The company spent $12.9 billion in operating expenses in 2019, the last full year before the pandemic. Its 2021 operating costs were just $4.6 billion, but Carnival generated just $1 billion in revenue compared to $14 billion in 2019.
It could be a worst-case scenario if Carnival sails a bunch of half-empty ships, spending all this money on its fleet but not generating enough revenue. Carnival currently has a solid cash buffer built up of $8.9 billion but could be forced to raise more funds if it blows through that.
Investor takeaway
Nobody knows what a stock will do in the short term, so perhaps Carnival will trade higher if the company gets some good news, like solid booking numbers. But fundamentals tend to drive the share price higher or lower over the long term, and it's currently tough to see a situation where Carnival shares go very far without the company improving its balance sheet significantly.
Unfortunately, a lot of Carnival's potential post-pandemic rebound has already priced into the stock; many investors just don't realize it yet. I think it's likely that Carnival's business survives the pandemic and gets back on its feet eventually. But as far as the stock goes, investors may be better off setting sail without Carnival in their long-term portfolio.
