Why I changed my mind and bought Carnival shares
I admit that I was not very bullish on cruise stocks in the midst of the coronavirus outbreak, despite their steep price drops. I think cruises won’t start sailing as soon as many hope, with delays likely until late 2020 or early 2021 – and that’s at the earliest. Without a vaccine, probably 18 months from now, it is unclear whether cruises will be able to depart before there is full-scale immunity.
Additionally, cruise lines are not domiciled in the United States and therefore do not pay corporate tax in the United States. This means that cruises are currently disqualified the $ 2.2 trillion stimulus from the CARES law that Congress passed in March. If the cruise delays are prolonged, this could very well mean bankruptcy. In addition, on Monday April 13, by a new “no-sail” command from the CDC, all cruises suspended their operations until June, causing a further drop in their stocks.
Still, I decided to go ahead and buy some Carnival Society (NYSE: CCL) on Monday while selling puts on the stock. Selling a put means that in exchange for collecting a premium now, I am forced to buy 100 shares if the Carnival stock falls below a certain strike price at some point.
So what on earth could I be thinking?
Carnival makes huge moves
More than any other cruise stock, Carnival wasted no time raising funds amid the crisis – and a lot. In fact, his moves have been so large that they should be enough to get the company through the blackout period this year and possibly next year.
Carnival raised money through the following instruments:
- $ 4 billion of 11.5% senior notes due 2023.
- $ 1.95 billion in 5.75% convertible notes due 2023, with a conversion exercise price of $ 10.
- $ 500 million in equity, issuing 62.5 million shares at $ 8.
Encouragingly, among the participants in the capital increase was the Saudi Arabia Public Investment Fund (PIF), which bought 43.5 million shares. Carnival Director Randall Weisenburger also intensified big, buying $ 10 million worth of stock at $ 8. The fact that an insider and the PIF are investing so much money in Carnival was encouraging, because while the new cash injections do not get Carnival to the other side of the crisis, the company appears to have buyers. debt and voluntary actions. to raise more bridge capital if necessary.
While the increase comes at a huge cost to shareholders, both via dilution of cheap stocks and high interest rate debt, $ 6.5 billion adds a fair amount of liquidity to Carnival’s balance sheet. , which only had about $ 1.35 billion as of February 29 compared to $ 12.9 billion in debt.
After the increase, Carnival is expected to have $ 7.9 billion in cash and $ 18.9 billion in debt, and the company’s 684 million outstanding shares likely grew to around 786.5 million. If the convertible notes were converted to $ 10, that would add another 195 million shares to the number of shares, bringing it to 981.5 million shares.
Estimates vary as to Carnival’s cash consumption, with analysts estimating between $ 500 million and $ 1 billion per month as of now. However, if the entire cruise line were to shut down for an extended period of time, it is possible that Carnival could temporarily put workers on leave, reduce executive pay, or reduce variable costs more than it has already done. . Other analysts estimate that if Carnival can start sailing at low capacity in the third and fourth quarters, it will only spend $ 2.2 billion for the entire year.
Assuming things get back to normal in two years …
In its 2019 fiscal year, which ended in November, Carnival achieved operating income of $ 3.28 billion and, after approximately $ 183 million in interest expense and minimal taxes, net income of $ 2.99 billion. Assuming the company returns to this level of operating income from FY2022 onwards, Carnival’s “new” benchmark earnings per share would be lower, due to both higher interest expense and higher interest expense. ‘a greater number of shares in circulation. But how much?
We may assume a further $ 460 million in additional interest expense on the 11.5% Senior Notes. Since the shares exceeded the convertible note’s $ 10 strike price, assume a full conversion. Using the same operating result from 2019, we get the following:
Metric |
2022 “New Normal” |
---|---|
Operating result (fiscal year 2019) |
$ 3,276 |
Interest expense, net |
($ 643) |
Taxes (fiscal year 2019) |
($ 71) |
Net revenue |
$ 2,562 |
Outstanding shares |
981.5 |
New earnings per share |
$ 2.61 |
Carnival’s “new” benchmark EPS of $ 2.61 is well below the $ 4.32 earned in 2019, showing just how expensive and dilutive the capital increase has been. Still, it is a much better alternative to bankruptcy.
In recent years, Carnival has traded with a P / E ratio of between 10 and 20, although even before the coronavirus crisis valuation levels had fallen to the lower end of the range.
Additionally, the new Carnival will be much more in debt than the pre-COVID-19 company, which may require a low P / E ratio. Still, a relatively modest P / E ratio of 10 would result in a net worth of $ 26. That’s in comparison to recent insider buys at $ 8 and the current share price around $ 12. Even assuming it takes two years to get back to that price, that’s still a good chunk of the upside and a margin of safety.
But the risks are always real
Of course, there are still risks. If cruise lines are banned from sailing until 2021, Carnival may need to raise more capital. If so, it could dilute earnings per share even further. And if the travel bans remain and the business continues to burn money, bankruptcy is still possible. As such, my position in Carnival is currently very small compared to the size of my overall portfolio.
But after the current massive capital increase, the risks of bankruptcy are significantly lower today than they were even at the end of March. If you are a risk tolerant investor, this makes Carnival a high value stocks worth exploring – just be sure to size your position based on your tolerance for risk.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.