When we last left Carnival Corp. (CCL) in July, the stock of the cruise line operator was in the midst of a significant drop, which put it below $20 a share mid-month. In the ensuing months, the stock rallied back above $26 by late September as things began looking up for the cruise industry following a lengthy shutdown due to the pandemic. Since then, shares have pulled back again and closed Tuesday at $20.15.
The issue with Carnival's stock remains the same -- it is overvalued. In order to survive the pandemic, Carnival issued a boatload of debt and stock. Total debt, which stood at $11.5 billion at the end of fiscal 2019, rose to $31.2 billion at the end of the most recent quarter, which ended Aug. 31. Net debt (after backing out cash) rose from $11 billion to $23.4 billion; as of Aug. 31, Carnival had $7.8 billion in cash and short-term investments. On the equity side, shares outstanding increased from 690 million at the end of 2019 to the current 1.133 billion.
The figures above mean a multitude of things to shareholders, none of them good. First, the massive increase in debt introduces a great deal of risk to their shares. It also has increased Carnival's interest expense, which was $206 million in 2019, climbed to $895 million last year and sits at $1.6 billion on a trailing 12-month basis. All that interest expense will lower profits once the company becomes profitable again. In addition, there's the massive dilution due to the increase in shares outstanding.
The best way to put this all together is via Carnival's enterprise value (EV), which is calculated by adding market cap and debt, then subtracting cash. At the end of fiscal 2019, pre-pandemic, Carnival's EV was $42.1 billion, with a share price of $45.08. That year, the company earned $3 billion, or $4.33 per share. The current EV, based on debt and cash data from latest quarterly balance sheet data, is $46.2 billion, but ignores the fact that the company likely has burned more cash since the quarter's end, further increasing the EV.
To get to the equivalent EV of November 2019 would imply a current share price of $16.50, but even that is misleading given the company's uncertain earnings picture. Consensus estimates predict that Carnival won't be profitable again until fiscal 2023, to the tune of $1.93 a share. That puts the two-year forward price-to-earnings (P/E) ratio at about 10.5, which may seem reasonable, but not in light of the great deal of uncertainty facing the company.
The lesson from Carnival is that a changing capital structure matters, and Carnival's has changed a great deal in the past two years. To view a price chart and surmise that Carnival, which was a $70-plus stock in early 2018, must be cheap because it's currently at $20 a share and the cruise industry is coming back to life ignores a great deal of information.
I am rooting for the cruise industry to make it all the way back; it has done a great job of making all-inclusive vacations affordable. However, it also is important for investors to be aware of the facts before deploying capital there.
