In recent days, cruise line operator Carnival (CCL 0.88%) (CUK 1.11%) raised $1 billion of new capital by issuing new stock. Prior to that secondary offering, it had been issuing debt to cover its losses as it attempts to work its way back to profitability after its pandemic-related slump. Here's what this latest move could mean for shareholders.
Navigating rough seas
Carnival's secondary offering added just over 100 million shares toits share count of nearly 1 billion. In addition, the deal's underwriters will have the option of buying just over 15 million shares at the offering price. Assuming that they exercise that option, the total of these new shares will amount to about 10.5% of Carnival's equity -- meaning that holders of its previously circulating shares just gave up 10.5% of their equity in the company overnight.
Since the onset of the pandemic, Carnival has struggled. In the fiscal year that ended in November 2019, it generated a record $20.8 billion in revenue and $2.9 billion in net income. Then came spring 2020. Cruise ships sailing from U.S. ports were docked for more than a year until July 2021. And even though it's sailing again, Carnival's revenue over the last 12 months was just $5.9 billion, while its losses amounted to $9.2 billion.
A year after resuming its operations, Carnival has yet to return to its former self. Though its revenue has increased each quarter since the company reopened, it still expects a slow return to profitability. Management has forecast net losses for the remainder of its fiscal 2022 and a return to historical occupancy levels in fiscal 2023. The cash infusion it got from selling those new shares could help the company stay afloat until then.
Previous shareholders who just saw their share get diluted may wonder why Carnival didn't once again raise capital through a debt offering instead of selling equity. There may be a couple of different explanations for that. First, the company has already raised significant debt to keep it afloat for the last two years. Before the pandemic, Carnival had a manageable $9.7 billion in long-term debt. Now, it has about three times as much: $29.3 billion. Potential lenders may have viewed allowing it to take on more debt as too risky.
Second, the credit rating agencies have assigned Carnival's debt a junk bond rating, which means they think the company has a higher than average risk of missing interest payments and defaulting on its debts. To sell new debt issued with a junk rating, Carnival would have to offer higher than normal interest rates to compensate bond buyers for taking on that greater risk, so the company may have found raising more debt cost prohibitive.
Set sail or abandon ship?
High inflation around the world has economic forecasts looking increasingly dire. In its July update, the International Monetary Fund lowered its global growth forecast by 40 basis points to 3.2%. A worldwide economic slowdown could hamstring Carnival's attempt at a comeback.
The leisure travel provider's $1 billion capital infusion may not be enough if the company cannot stem its losses. In its second quarter of this fiscal year, Carnival lost $1.8 billion. That was better than the $2.8 billion it lost in the third quarter of fiscal 2021, when it resumed sailing -- but, again, the company doesn't expect occupancy levels to return to normal until 2023.
On the other hand, Carnival bulls might point out that shares are down by more than 55% this year and a return to glory could make the stock attractive at its beaten-down price. In 2019, the company generated adjusted earnings per share (EPS) of $4.43. Assuming the company returns to normal levels, as management expects, and after adjusting for new debt and shares issued since 2019, Carnival could arguably get to $1.53 in adjusted EPS. If the bulls view the higher debt as risky and assign a lower-than-average P/E ratio of 8 to their forecasted adjusted EPS, the shares could be worth over $12, or about 33% above today's price of around $9. This hypothetical scenario assumes no further debt or shares are issued.
Still, that's a long shot. The value of Carnival stock appears highly subjective, with Wall Street analysts forecasting 12-month price targets that vary widely, from $7 to $29. Make sure you do your homework on this one.