With its shares down 33% year to date, Carnival Corporation (CCL -0.49%) isn't enjoying the post-COVID-19 bull run you might have expected. While the return of cruising has led to a boom in sales, it will take years for the company to shed its mountain of debt. Rising interest rates and a possible recession could make the situation significantly worse. Let's dig deeper.
A bittersweet reopening
The cruise industry was hit incredibly hard by the coronavirus pandemic; fast-spreading viruses and tightly packed ships don't mix well. And in 2020, the U.S. Centers for Disease Control and Prevention imposed a no-sail order on the industry, which it replaced with a now-voluntary conditional sail order in 2021 and early 2022 designed to ensure a safer return to normal operations.
Image source: Getty Images.
Now that federal restrictions are lifted, Carnival and other cruise operators are enjoying a boom in revenue. First-quarter sales skyrocketed from $26 million to $1.6 billion year over year (representing a 6,000%-plus increase). But that is still down 65% from the $4.6 billion generated in the first quarter of 2019, even though most of the company's fleet have resumed guest operations.
Carnival's bottom line also leaves much to be desired. Despite the surge in revenue, operating losses only decreased by 2% to $1.49 billion. This result had a lot to do with variable expenses like employee salaries and fuel costs, which have been elevated in recent months. Management plans to address this challenge by replacing smaller, less-efficient ships with larger ones and pivoting to liquefied natural gas (LNG), a cheaper alternative to diesel expected to help deliver a 10% reduction in fuel consumption across the fleet.
That said, it's hard to see how Carnival can absorb inflation-driven cost increases without passing them on to consumers through higher pricing, which could soften demand and slow down future growth.
The balance sheet is in shambles
Carnival Corporation needs all the growth it can get because of the dire state of its balance sheet. Despite being one of the industries worst affected by the COVID-19 pandemic, cruise companies didn't receive a bailout from the U.S. government. Instead, they relied on low interest rates to rack up the massive debts they needed to survive the crisis. Now, that strategy is coming back to bite them.
As of the first quarter, Carnival holds almost $30 billion in long-term debt, which dwarfs the company's $6.4 billion in cash and equivalents. Unless operations improve dramatically, Carnival doesn't have a good way of dealing with this problem.
In May, the company raised $1 billion in senior notes due in 2030 to pay off older debts. However, with a coupon rate of 10.5%, this new debt is quite expensive. And with the Federal Reserve expecting to raise its federal funds rate to combat inflation, the refinancing strategy could become harder to sustain over the long term.
No time to recover?
It isn't all doom and gloom for Carnival. The company's management is hopeful that the summer season (traditionally its most lucrative period) could bring adjusted EBITDA profitability. And this could help the cruise giant manage its debt better. But with Bloomberg reporting that 30% of its surveyed economists believe a recession will happen in the next 12 months, Carnival could be heading for another crisis before it even recovered from the first one. Investors who bet on the stock now face significant risk.
