As the travel and tourism industry recovers, airlines and cruise lines are still trading at depressed levels. The top airlines, Delta (DAL) , United (UAL) , and Southwest (LUV) , are down on average 50% from pre-pandemic highs, while cruise stocks are down a whopping 80%.
After Delta and Carnival's (CCL) recent earnings reports, it appears clear which industry's stocks are buyable and which to avoid. But let's take a closer look.
Delta reported a solid quarter and has finally gotten back to producing free cash flow. During the pandemic, the airline racked up losses covered by an $24 billion increase in debt. From its peak enterprise value in 2018 of $52 billion, Delta is down about 25%. The shares can rally 60% to $47 before reaching its enterprise value peak, not including the expected cash flow likely directed to paying down debt. Delta produced $1.6 billion in free cash flow in the past quarter with a strong outlook. Conceptually, if Delta continues on this fundamental path through 2023, it can pay down enough debt to raise its enterprise value peak to $60 per share.
Carnival's earnings still demonstrate they're yet to turn the ship around, burning through $2 billion in cash for the quarter. The company hasn't yet hit full operational availability of its ships, currently at 91%. Cruise pricing has remained soft, decoupling from airfare and hotel pricing, which may reflect higher supply growth. More problematic is Carnival's debt load.
Carnival had pre-pandemic debt of $10 billion, which is currently up to $35 billion after capital needs to cover enormous pandemic losses. Equity dilution increased outstanding shares by 65%. From its peak EV in 2018, Carnival's enterprise value is only down 20%.
Carnival has no imminent liquidity risk, but the company may be facing difficult financing decisions down the road. Over the last six months, the spread on Carnival's debt has widened from 450-basis points to over 1000bps. Last month, Carnival raised $1 billion in debt at a 10.5% yield -- those bonds are now trading at over a 12%. Carnival's interest cost on their $35 billion in debt is $1.6 billion, or around a 4.6% average rate. Given Carnival's much higher cost to raise capital, Carnival's interest expense can increase dramatically. Plus, about one-third of their debt is a floating rate, raising the interest expense on those bonds sooner than the maturities would suggest.
The credit rating on Carnival bonds is B-rated, but the marketplace currently deems them more akin to a CCC, with yields slightly over 14% on bonds maturing in 2027. Moody's and S&P are often slow in reacting to a changing credit risk profile by downgrading ratings, but the market seems concerned that Carnival may fall deeper into junk territory.
Carnival shares would have to double to hit its peak pre-pandemic enterprise value, a questionable risk vs. reward. Given all the challenges, the stock may be dead money at best. There's a substantial risk of dilutive equity raises to lower their leverage from 6.5-times closer to Carnival's target of 2%-2.5%. As Carnival continues to burn cash in the second half of 2022 and $4 billion in debt matures through 2023, replacing that liquidity will come at a steep cost either in equity dilution or coupon payments.
Running through the exercise of these two "reopening" stocks theoretically regaining their peak pre-pandemic enterprise values shows that the equity of both can double. Yet, the risk profile of Carnival is far too skewed negatively and makes no sense to buy vs. Delta given similar upside potential. Carnival's stock is much further down from its old highs, but a bloated balance sheet and equity dilution have kept its enterprise value high. Continued challenges plaguing Carnival and the cruise industry make the group one to avoid. Delta and the airline stocks have often been difficult investments, but the industry is the clearer reopening play.