The last I left cruise line operator Carnival Corp. (CCL) in early April the stock was rising and approaching the $30 level based on little more than the prospects that a return to cruising was on the horizon. The fundamentals did not support that price, nor could the rosiest of earnings scenarios. However, we all know the markets can interpret events and situations however they see fit, and in this case it has been rainbows and unicorns for the most part.
Carnival eventually did breach $30 earlier this month (it closed last Friday at $28.18) as plans were unveiled for a July/August restart for a handful of ships, including the Vista and Breeze (from Galveston starting July 3 and July 15, respectively), Mardi Gras (from Port Canaveral starting July 31), Sunrise (from Miami starting Aug. 14) and Panorama (from Long Beach starting Aug. 21). Still, others are on hold through the end of August, including the Pride (Baltimore), Sunshine (Charleston), Dream (Galveston), Ecstasy (Jacksonville), Liberty (Port Canaveral), Conquest (Miami), Sensation (Mobile) and Glory (New Orleans).
It is good news that cruises are restarting, and I honestly hope the path is a smooth one for cruise line operators and passengers. Any further delays or shutdowns could be devastating.
Yet there are things investors need to know about Carnival, and they should apply the same logic to the other cruise line operators before taking a position in any of them. We often focus on stock price alone -- in this case, with sentiment along the lines of "Carnival was a $50 stock just before the pandemic and a $72 stock in 2018, so it should get back to those levels." Now sometimes things will happen that way. However, in this case much has changed outside of the stock price that will influence CCL's valuation.
First, Carnival had to make big changes to its capital structure in order to survive its shutdown for more than a year. Carnival sold a great deal of stock, increasing its shares outstanding by 411 million, or 60%, from February 2020 to February 2021, which dilutes earnings per share substantially. Peak earnings for CCL were $3.15 billion, or $4.44 a share, in fiscal 2018. Spreading the same bottom line over the current share count yields EPS of $2.88.
However, share dilution is just part of the issue. CCL also issued massive amounts of debt during the pandemic. Net debt (debt minus cash) stood at $11.6 billion pre-pandemic and was $20.1 billion as of the latest quarter-end. Compounding the earnings dilution issue is the increase in quarterly interest expense associated with the increased debt. This past quarter (February), interest expense was $398 million; it was $65 million for the same period last year.
Putting it all together, a current market cap of $31.2 billion puts the enterprise value (market cap plus debt minus cash) of Carnival at $51.3 billion. For comparative purposes, if we go back to November 2019, Carnival's enterprise value (EV) was about $42 billion. Shares at that time were trading in the $45 range, and that year the company earned $4.32 a share. To get to an equivalent EV with the current level of debt and shares outstanding would imply a share price just above $19 a share. However, getting to $4.32 a share in earnings would be much more difficult now given the increases in shares outstanding and interest expense.
Carnival's current valuation just does not make sense, but sometimes valuations just don't make sense for longer than you can tolerate.