Cruise line Carnival (CCL 1.13%) has become a popular comeback story on Wall Street. COVID-19 did a lot of damage to tourism-focused companies like Carnival, which are just now getting their sea legs back under them. But an investment in the cruise operator gets more complicated as you peel back the layers of the onion.
Carnival could hit the high seas at full capacity over the next several years. Still, its complicated financial situation could lead to troubles and subpar returns for investors. Here is why you're better off staying off this cruise stock.
Survival came at a cost
The pandemic brought the company to its knees. The last place you want to hide from an airborne virus is on a ship, isolated at sea among hundreds of strangers. Ships are also expensive to maintain and operate, and the travel restrictions resulted in billions of losses for Carnival, which was burning an average of $650 million of cash every month in the early phases of the pandemic.
The company had to take drastic measures to survive, and that included borrowing a ton of money. You can see in this chart its debt has more than tripled from the start of 2020 to today.
Data by YCharts.
It's not ideal, but the surge in debt was necessary to Carnival's survival. Investing isn't about what once was; it's about looking forward, and investors must now grapple with a company whose balance sheet has taken on water.
The bill is coming due
This is where things get complicated for Carnival. The company has many loans maturing over the next several years. For example, it has $991 million of debt coming due in the fourth quarter of this year. It has a total of $2.4 billion coming due in 2023 and another $4.9 billion in 2024. A whopping $16.9 billion is expected to mature through 2026.
The problem is Carnival isn't a business that produces tons of cash profits. It spends billions each year on its fleet to maintain it. Operating profits were $5.5 billion in 2019, the last year before the pandemic. However, it spent $5.4 billion on property and equipment (ships) that year, rising steadily from $2.9 billion in 2017. That leaves the company with a few billion dollars in free cash flow in a best-case scenario. Historically, free cash flow has been much lighter as you can see below.
Data by YCharts. Reported on a trailing-12-month basis.
Carnival's free cash flow was a negative $882 million in its fiscal 2022 third quarter, ended Aug. 31. In other words, even when it's actively trying to conserve cash, the need to open its business is resulting in significant cash burn.
The company does have $7.1 billion in cash on its balance sheet, so near-term liquidity shouldn't be an issue. Carnival will pay its bills due in the fourth quarter.
Rising rates are going to hurt
But this combination of ongoing cash burn and loan repayments could dwindle its reserves fairly quickly. There's a good chance Carnival must begin refinancing debt instead of paying it off, and the current macroeconomic environment probably won't be kind to such an effort. The company is in financial distress with interest rates currently between 2% and 8% (some of them variable) on its loans coming due over the next several years. Central banks around the world are raising interest rates to combat inflation, so new loans might be even more expensive.
Data by YCharts. TTM = trailing 12 months.
As a result, Carnival will spend a lot of money on interest expenses, which will only subtract from its cash profits, limiting its ability to service and pay down its debt.
Compounding is a powerful force, and the company is in grave danger of ending up on the wrong side of it. A bear market tends to bring down all ships at sea, and there are better opportunities for investors looking for potential deals on stocks that can rebound. Chasing a company with looming financial woes like Carnival seems unnecessarily risky right now.
