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Shorts Betting On Carnival Corp.’s Bankruptcy May Be Disappointed

A Fresh Look At Carnival Corp.’s Situation

In a time when tech stocks are growing at unfathomable paces, lofty valuations and uncertainty spark discussion of the chances of sector rotations. The importance and need for value investing is stronger than ever, and the story is no different with Carnival Corporation (CCL). When investors realize the resilience of the cruise industry during recessions, the ability of the company to service its debt through the pandemic and future maturity dates, and the pent-up demand evidenced in countries around the world, the stock may possibly be too late to jump onto.

Since the time of my last article publication, when CCL was trading at $8.02, it rallied to as high as $25.28 (almost hitting my two-year price target of $26 in two months), before dropping back to its current price of $15.47 amidst reopening concerns and surges in new COVID-19 cases.

In this new analysis, I take a new look at the company’s current status after fresh capital raises, financial updates/guidance, and the new financial environment. There will also be a new debt calculation, why cruises will do well in a recession, and three different scenarios Carnival might go through.

CCL Chart

(Source: Trading View)

Company Revenue Generation by Region

With regions like Asia or Europe (45% of revenue) opening up quicker than the U.S. due to better containment of new COVID-19 cases, they have already begun preparations to resume sailing in the near future.

Carnival recently announced German brand AIDA Cruises would begin sailing from Kiel, Germany starting on September 6, followed by sailings from Hamburg on September 12. Additionally, as of August 14, 2020, AIDA Cruises has also received final approval to sail from its flag state of Italy.

On the other hand, the U.S. itineraries were pushed back to at least October 31st with an approximately 30-day waiting period before ships are ready to accommodate passengers. In that case, I forecasted Carnival to have 0% U.S. ship occupancy through the rest of 2020. Europe, Australia, and Asia are forecasted to pick up sooner due to more successful containment and final stage re-opening discussions with the respective governments there. As a result, 2021 average occupancy rates for Carnival as a whole, by my forecast, will be 36.75% of pre-COVID-19 occupancy rates. Then, the rate picks back up across all regions when a vaccine is projected to be released to the public in limited quantities by the latest in Q4 2021. My projections lead to 64.8% and 88.6% of pre-COVID-19 occupancy rates in 2022 and 2023 respectively, as shown below.

Carnival Occupancy RatesCCL Occupancy Rate

(Source: Author’s projections)

How Much Longer Will Carnival Last?

With recent new capital raises, it’s timely to look again, at the liquidity of Carnival and how long the company can stay solvent throughout the pandemic. There are two main risks for the company regarding the important 2023 debt maturity year. First is the concern for a prolonged zero-revenue case with cash burn. Second is if Carnival currently has the liquidity or means to attain the needed capital to stay solvent until then. Below are my projections for the company’s current liquidity scenario.

Debt: Since my last article at the end of April when it had $13.75 billion of debt, Carnival raised $1.86 billion and €800 million First-Priority Senior Secured Term Loans. It also announced the pricing of $900 million Second-Priority Senior Secured Notes due 2027. $885 million in convertible notes due 2023 was paid back, bringing the total debt amount to roughly $16.364 billion. However, the amount due by the end of 2023 would be roughly $13 billion.

Cash: On August 14, 2020, Carnival announced that its cash and cash equivalent balance was $7.9 billion as of July 31, 2020. Factoring in 2 weeks of cash burn of $325 million brings this down to $7.575 million.

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Cash Gain (Burn): Management guided about a $650 million monthly cash burn, which includes ship operating and administrative expenses, working capital changes, interest, and committed capital expenditures. I projected a full cash burn amount throughout the rest of 2020, and then a breakeven percent in 2021 considering it takes roughly 25% of ship occupancy to do so. And then, in years 2022 and 2023, I multiplied the pre-COVID-19 cash flows by the respective occupancy rates forecasted above (64.8% and 88.6% respectively) and added $400 million representing the amount saved through capex and dividend/stock buyback cuts.

Debt Paydown: Having paid back about $800 million in convertible notes due 2023, about $1.2 billion is left, due in 2020. After that, $2 billion is due in both 2021 and 2022, with the lump sum of $6.9 billion payable in 2023. Under my calculations as shown below, Carnival will have a $4.9 billion deficit if it doesn’t raise any more capital. As stated in the company’s last earnings call, we can expect an additional debt capacity of $6 billion if needed, which is more than enough for the $4.9 deficit. This gives the company the liquidity runway needed for its big 2023 maturity date.

CCL Bankruptcy Chart

Cruise Industry During a Recession

The cruise industry has historically performed well throughout economic recessions. Despite the deteriorating global economy in 2008, net cruise revenues increased 12.9% year over year to $11.5 billion, driven by both a 6.7 percent increase in available passenger capacity and a 3.7% increase in passenger ticket prices, partially offset by a 1.6% decrease in onboard sales. Cruise occupancy held stable at 105.7 percent.

Obviously, a recession does not do any sector favors. Specifically because there has been a shift towards more of a middle-class passenger target, increasing consumer discretionary spending sensitivity might cause a more drastic decline in prices and occupancy levels than seen in previous downturns. And with the company’s current dangerous debt levels with general avoidance of cruises, that could be a tough problem to have. However, I feel more comfortable that the recent surge of asset prices has been driven by tech. At the beginning of the year, Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG, GOOGL), Amazon (AMZN) and Facebook (FB) accounted for 17.5% of the S&P 500 and have since led the way in the rally from March lows. From the chart below, during both the crashes of 2001 and 2008, the tech-heavy Nasdaq fell as much as 44%, while cruise lines dropped 18 and 16% respectively. If I were to be in a more favorable risk-reward industry right now, it would be cruises.

Cruises during recessions

(Goldman Sachs Cruise Industry Chart)

Three Hypothetical Scenarios: Base, Best, Worst?

Below are three hypothetical scenarios that Carnival faces.

Downside Case (15% chance of happening): Additional waves further prolong not just U.S re-sailings, but also global re-openings. Global confidence in leisure activity stalls and monthly cash burn continues under a near-no revenue state. A vaccine doesn’t come at the anticipated 2021 year-end date. U.S occupancy levels stay at 0% through the middle of 2021, while Europe, Asia, and Australia hover around 20% each. This coincides with a drop in tech, bringing down the entire market. In this case, there is danger for Carnival to continue operating as a going concern without considerable liquidity measures. In this case, expect a drop to similar levels as seen during March 2020 lows ($8), when similar concerns were present, which represents about a 48% discount to the current price.

Base Case (50% chance of happening): Same occupancy rates as projected earlier. A vaccine is then developed by the end of 2021 and early doses given to the public. Low interest rates and sustained earnings growth in tech sustain the bull market. Stringent safety measures are implemented throughout the ships, boosting consumer confidence and a quicker re-opening in North America. In this case, valuations should be at $26 within the next two years, as forecasted in my previous model.

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Upside Case (15% chance of happening): A vaccine is released to the public ahead of schedule, as early as the summer of 2021. As a result, North American cruises push ahead to 40% occupancy in Q2 2021, as well as a 10% boost to my earlier projections in other regions. This would result in a 53% occupancy in 2021 and 77% in 2022, both of which would increase cash flow to pay down the 2023 debt. As long as chances to boost liquidity to ensure the going concern of Carnival increase, it’s a matter of time before the company returns to its pre-COVID-19 EBITDA levels, albeit at a lower multiple. Or, in a similar situation, if all passengers are required to get rapidly tested for COVID-19 before going onboard, I see this as having an effect similar to releasing a vaccine earlier.

Catalysts

In order for Carnival to achieve the base or upside cases that I mentioned, some key catalysts have to come together.

Rapid COVID-19 testing: Requiring temperature checks before going onboard is futile, as asymptomatic cases run the risk of COVID-19 transmission just as much as, if not more than, symptomatic ones. So, the question turns to testing. The NBA as well as other sports leagues and select businesses have been utilizing rapid testing through nasal or mouth swabs and can receive results in less than an hour. So far, COVID-19 tests are covered by the government if one has reasonable belief that they have similar symptoms, and these have a general 24-48 hour turnaround. However, there has recently been an issue of a delay in testing results, with some taking as long as 19 days. The U.S. is behind other countries in results turnaround time, so it will take a drastic improvement in efficiency on the part of the government to make rapid testing for businesses both affordable and fast. And when rapid testing for companies does materialize, which I think is likely given the positive effect it’ll have on the economy, a majority of cruise passengers will possibly return with greater confidence. A system can then be put into place involving testing all incoming passengers inside a safe boarding room before cruise embarkation.

Operation Warp Speed: This plan, as announced by President Trump, aims to deliver 300 million doses of a safe, effective vaccine for COVID-19 by January 2021, which would be earlier than any of my projections. Some firms like Moderna (MRNA), Johnson & Johnson (JNJ), AstraZeneca (AZN), and more have received direct funding promises to make and distribute roughly enough doses for each citizen of the United States. The timeline is tight, and the question of actually achieving it is important to consider. For reference in a similar outbreak, the H1N1 vaccine was developed in 6 months. But keep in mind, that was for an influenza vaccine, which the medical community already had much more experience understanding every year. And among the fastest novel disease vaccine to be developed was the current mumps vaccine, which took approximately 5 years to be administered to the public. But with the severity of COVID-19, reaching 21.2 million cases and 765k deaths as of August 15th 2020, the entire world is laser-focused on developing treatments for it. And with that comes the possibility for a quicker release and a great boost to consumer confidence for cruises.

CDC Approval for North American cruises: Recently, the CDC has begun accepting and posting comments from the public on whether or not cruises should restart and be allowed to sail, with the prevailing sentiment being a readiness to cruise again. The current sailing restriction is through the end of September, but cruise liners like Carnival have been voluntarily extending their no-sail orders to the end of October, citing confidence in their decision. But as North America is 55% of Carnival’s revenue, it’s more favorable to restart voyages by the beginning of 2021, which is currently on a positive trajectory to happen.

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Pent-up demand pushing both occupancy and prices up: One of the more positive trends coming out of the panic in March is higher-than-normal cruise bookings from even pre-COVID-19 times. Royal Caribbean announced that “there was pent-up demand” and “remarkable” bookings for its international cruises in 2021. This echoes what other cruise companies have said about demand for 2021 being in historic ranges. And it made sense to me at the time of my last article that the promise of a cheap vacation with safety measures in place and the chance to visit multiple different cities and countries would attract many customers. If this continues to be the case in other regions, as well as when North America starts opening up, it bodes well for all markets Carnival operates in.

Government Aid: Back in March, there was a whole fiasco about Carnival’s legal inability to receive aid from both the government PPP or other stimulus packages because of its Panama incorporation. But that didn’t stop the company from requesting or receiving aid from other countries. In July, it was announced that Carnival qualified for up to $700 million in aid from the UK, which can pay off a good portion of annual interest payments or the $2 billion in debt due each year. There’s a possibility for other countries that Carnival either operates in or hires a substantial number of workers from to follow suit. And there’s still a last-resort scenario that can force it to register back in the United States to qualify for government support if needed, but management hasn’t mentioned plans to do so.

Sector Rotation: We caught a glimpse of just how oversold this industry was back in June, when CCL rallied to just shy of $26 from $7.97 in two months, a 225% increase. While not a consumer staple, there was been no clear underperfomance in times of a recession with cruises, and proof it has actually performed better than the overall market. This is a better play on the inherent risk-rewards in the market right now, as tech is sky-rocketing on a temporary transition to the digital world.

Conclusion

A thesis is never clear until it’s too late. Sure, cruises aren’t earning any revenue right now. Sure, there’s a load of debt that has to be paid back in 2023, and that’s hard to comprehend with no cash flow right now. But we have to dig into the numbers and figure out if the company has the capacity to pay it back, and slowly but surely, return to pre-COVID-19 occupancy rates through unlocking of catalysts. And in comparison to the overall market, tech stocks, and how much of a discount CCL is trading at, it’s a good pick with a favorable risk-reward ratio. Look beyond the immediate few years and grab up some CCL shares for a long-term Hold.

Disclosure: I am/we are long CCL. 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.

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