CCL

Carnival Corporation

9.75
USD
4.61%
9.75
USD
4.61%
6.11 23.86
52 weeks
52 weeks

Mkt Cap 9.49B

Shares Out 973.54M

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Carnival Cruises Into Oblivion

Summary CCL's Q3 earnings highlight long-term issues. Constant dilution and debt issuance have created a terrible situation for shareholders. This one is a strong sell despite making new lows. Looking for a helping hand in the market? Members of Timely Trader get exclusive ideas and guidance to navigate any climate. Learn More » The cruise lines have, unsurprisingly, been dogs since COVID began. There have been periods of hope for the stocks, but those have all turned out to be false. Carnival (NYSE:CCL) reported earnings for the third quarter on Friday, and results disappointed the market such that a stock that was already very near its lows of the past thirty years (!) fell a further 23%. As we’ll see, even at $7, I still don’t find cause to buy Carnival. The last time I covered the stock, it was trading for $28, and I said the rally that was ongoing at the time was unsustainable. Shares are down 75% since then, but I don’t think the stock has fallen far enough yet. Key support broken We’ll start with the technical picture, and we’ll begin with the daily chart. The action on Friday broke a key support level at a time when the indicators continue to weaken, so the floor has disappeared from the stock as I see it. The summer lows produced a zone of support between $8.10 and $8.40 (roughly) that held a few times. However, Friday’s selloff was simply too intense and the stock made new lows, and finished on the low of the day. That’s about as bearish as it gets for a day’s trading, and the momentum indicators all continue to worsen as a result. The accumulation/distribution line plummeted yesterday given the heavy volume and the fact that the stock sold off right to the closing bell. The PPO and 14-day RSIs are headed straight down at the moment, as is relative strength. The stock is very weak, in a very weak group, and is underperforming that very weak group. There simply isn’t anything to cling to if you’re bullish here. Let’s zoom out to the weekly chart to get an idea of the longer-term picture. We can see, critically, that the stock just blasted through the COVID panic low of $7.80 that was set in March of 2020. That low had absolutely no bearing on trading activity on Friday, as the bears are completely in control. The accumulation/distribution line made another low that was far lower than the prior one, so again, support levels are being ignored and there’s nothing to cling to. This business is impaired Revenue was up almost 80% sequentially, as Carnival and other operators continue to get back to some semblance of normal with cruise operations. Carnival is almost at 100% in terms of operating capacity now, which is a vast improvement over the prior several quarters. That’s good news, but it was expected, and it’s not enough. Passenger cruise days were up 55% from Q2, but remember that Q2 had decreased capacity. Occupancy was up 15 percentage points, hitting 17.7 million passenger cruise days on capacity of 21 million. Carnival said onboard spending was strong in Q3, which is another good sign, and it hit positive adjusted EBITDA for the first time since the pandemic started. All of that is fine but it was also all expected. We knew cruise lines were going to increase capacity, we knew passengers would return, and we knew they’d spend while onboard. That’s just getting the business back to normal, but where it remains an enormous challenge for Carnival is with profitability and financing. Cruise lines require enormous capex every year, even if no new ships are built. Running cruise ships is ruinously expensive so even in good times, capex for Carnival is billions of dollars a year. The company had over a year of essentially no revenue, which meant financing had to be done elsewhere. That “elsewhere” happened to be huge amounts of new debt and common share issuances. The company issued another $1.15 billion of common stock during Q3, using the proceeds to pay down 2023 debt maturities. If this isn’t an indication that this business cannot sustainably finance its own operations, I’m not sure what would be. The company also exchanged $339 million of convertible debt due 2023 for the same due in 2024, meaning yet more dilution is on the way. Those extra shares may not matter while the company is making losses, but when profits return, each share of stock outstanding will have less and less of each dollar of profit. We can see the issuances here, where the share count nearly doubled from pre-COVID levels. That’s a huge amount of dilution and what it means is that the company will have to earn about double the amount of money it did pre-COVID just to meet the same EPS levels. It also means its ability to continue to use common shares as a piggy bank is impaired because it’s already done a lot of damage just to float the company’s operating costs during COVID. Let’s start with revenue revisions as we look forward, as they show at least a bit of hope for the remaining bulls on Carnival. This year’s estimates just continue to melt away but in a silver lining, there is some upward momentum for the out years. Whether any of that comes to fruition is anyone’s guess, because analysts have been quite wrong on this stock before. However, this could certainly be worse. And as I said above, it is expected that revenue should recover strongly because cruise lines are able to operate pretty much as they did prior to COVID at this point. Unless people just decide they don’t like cruises anymore, revenue will move a lot higher. Where things get dicey for the bulls is with earnings, for a lot of the reasons we’ve already discussed. There’s no silver lining here, as the out years are flat-to-down. But as the company continues to issue new shares, these estimates have to come down, given the shares are being issued to simply afford to operate; they’re not being issued to finance an acquisition or some other growth avenue. It’s just an extra cost to overcome, so given the debt and dilution problems Carnival has, I have a hard time seeing any upside here. Speaking of debt, below we have quarterly outstanding net debt, which takes into account cash and long-term debt positions. Carnival had a lot of debt prior to COVID, because like I said above, cruise lines are very expensive to operate, so they tend to have a lot of leverage. Carnival’s net debt load is still ~$28 billion, which is an amount it has no chance to pay back anytime soon through operating profits. Annual operating profit was roughly $3.5 billion pre-COVID during the best of times. I have my doubts it will be that high at any point in the next several years given how the company’s capital structure has changed, which means that even if 100% of operating profits were dedicated to debt reduction, it would take years and years just to get back to pre-COVID levels of debt. The company has the above maturities in the next handful of years, so either these will get reissued at higher rates – in case you hadn’t noticed, interest rates are a lot higher today than they’ve been in the past decade – or more common shares will need to be issued. Neither of those is a good outcome for shareholders, but Carnival has no choice. Let’s now turn our attention to the damage on the income statement from all that debt. Below we have quarterly interest expense and operating income to show just how massive this problem is. Interest expense is in the billions of dollars today, with negative operating income to boot. While operating income will turn positive – likely next year – this interest cost isn’t going anywhere. And as the company reissues maturing debt it cannot afford to pay down, this will only get worse as rates have moved higher. I mentioned capex above as well, which is just one more thing Carnival has to finance. Below is quarterly capex and operating cash flow to illustrate this issue. Operating cash flow wasn’t even enough pre-COVID in some cases to cover capex, but operating cash flow has been negative for almost three years now. Even when it returns to being positive, capex must compete with interest expense and debt reduction in ways it never did before. We can see here the company’s solution is to drastically reduce new builds in the coming years, and while that will reduce capex, it has the risk of reducing competitiveness as well. Customers in leisure activities such as cruises want the best amenities and modern designs, and an aging fleet for Carnival leaves the door open for its competitors. Let’s value this thing Valuing a stock with no earnings can be challenging, but let’s start with Carnival’s pre-COVID valuation. This chart shows the year leading up to COVID, which should be pretty representative of “normal” conditions. The average forward P/E during this time was 10.8, with the peak at 12.3 and the trough at 9.2. That puts us in a pretty good spot to say a normal valuation would be something like 10 or 11 times forward earnings. However, this was before the massive share issuances, before the slashed capex, and before the nearly tripling of net debt. Those factors absolutely warrant a lower valuation, so my estimate of fair value is now 7 to 8 times forward earnings. If you believe these estimates, the stock is fairly priced for next year’s earnings, and cheap for 2024. However, given the factors we discussed above, I believe the downside risk of these estimates is much higher than upside risk. I believe that’s what Wall Street told us on Friday with the massive selloff as well, and that institutional investors have positioned for lower estimates via selling the stock heavily. The bottom line here is that I still think Carnival is an impaired business. It has little to no ability to finance its own operations, and I don’t know when or if that will change. It has massively diluted shareholders – and continues to – because its balance sheet is already a mess. I simply don’t see any reason to buy this stock, particularly since support levels on the chart are being ignored. There are so many great businesses on sale today, there is simply no reason to waste your capital on this one. If you liked this idea, sign up for a no-obligation free trial of my Seeking Alpha Marketplace service, Timely Trader! I sift through various asset classes to find the best places for your capital, helping you maximize your returns. Timely Trader seeks to find winners before they become winners, and keep you out of losers. In addition, you get access to our community via chat, direct access to me, real-time price alerts, a model portfolio, and more. Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Comments (9)

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