Risk is a big part of investing. An investment's return compensates investors for taking on the risk of a possible loss. Typically, the higher an investment's potential return, the greater the risk of loss.
Carnival (CCL -0.66%) and Medical Properties Trust (MPW -1.10%) certainly have many risks. However, they also offer investors tremendous upside potential if they can navigate the risks and execute their plans.
A boatload of debt
Carnival had to cease operations during the pandemic. While its revenue dried up, it still had expenses to pay. That forced the cruise ship operator to take on a boatload of debt to stay afloat. It also sold tons of stock to shore up its balance sheet, which diluted existing investors. The debt issuances shifted value from equity investors to creditors:
CCL Enterprise Value data by YCharts
That chart shows that debt has become a much more significant percentage of the company's total enterprise value while its equity market cap has shrunk. The company's massive debt load has become a huge weight holding down its stock price.
Carnival's debt peaked at $35 billion and started declining as the company reversed its losses and began generating positive cash flow. It currently expects to produce enough cash to deliver more than $10 billion in debt paydown over the next three years. That would transfer this value from creditors to equity holders. It implies that the company's market cap (and thus stock price) could gain more than 50% during that time frame. That assumes no further increase in total enterprise value, which is conservative since its revenue and earnings are on track to exceed their pre-pandemic peak.
However, there are risks to the company's debt reduction plan. It assumes revenue will continue rising and its margins will expand, driven by the ongoing strong recovery of the cruising industry and the expansion of its fleet. While that's a reasonable assumption if the global economy remains in expansion mode, a recession could wreck those plans. It could cause consumers to reduce spending on discretionary items, like large vacations. A slowdown could impact Carnival's revenue and margin growth, affecting its ability to deliver on its plan to transfer value from creditors to investors.
Working to get back to full health
Medical Properties Trust is in the same boat as Carnival. The healthcare REIT has lots of debt, which has weighed on its equity value. It's also dealing with some financially troubled tenants.
Those two factors, along with rising interest rates and tighter credit market conditions, have made it more difficult for Medical Properties Trust to refinance debt as it matures. That's led the REIT to sell hospital properties to pay off debt. It has also worked to provide additional support to its tenants and recently cut its dividend.
Medical Properties Trust still faces a long road to recovery. It must close a critical transaction with one of its largest tenants for a stake in its managed care business and eventually monetize that interest to recoup lost rental income and real estate values. It also needs to continue to sell hospital properties to shore up its balance sheet. That could help lift some of the weight on its valuation.
The REIT owned over $19 billion of hospitals and other assets at the end of the second quarter. However, its total enterprise value was recently down to $13 billion, comprising about $10 billion in debt and $3 billion in equity market cap value. That's down from $24 billion at its peak last year because of the plunge in its stock price (and equity market cap value).
If Medical Properties Trust's tenant issues improve and it can continue to reduce debt and find other ways to extend its maturities, it would help lift the enormous weight on its stock. Shares could easily double in value (or more). However, additional tenant issues or problems selling assets for full value could put more weight on the stock price.
A healthy dose of risk and reward potential
Carnival and Medical Properties Trust have lots of debt, which makes them risky stocks. While they're working to improve their financial situations, they could continue to face obstacles on their road to recovery. Even though they have lots of upside potential, their risk profiles might be too high for some investors.
