Today’s stock pick is not for the feint of heart. It requires an ability to be fairly headstrong and to look beyond the facts towards the brighter horizon.
Carnival Corp (NYSE:CCL) – a British-American dual-listed (NYSE and LSE) cruise operator – operates nine brands: Carnival Cruise Line, P&O Cruises (UK), P&O Cruises (Australia), Cunard, Holland America, Princess Cruises, Seaborn Cruise Line, Costa Group and AIDA Group. Carnival also have minority interests in CSSC Carnival Cruise Shipping (based in China), Grand Bahama Shipyard Ltd (a repair and maintenance facility) and in the “White Pass route” – port, railroad and retail operations in Alaska. CCL has watched its share price fall a titanic amount over the last five years.
As most of you will know there are two main reasons for a company opting to take bankruptcy. Firstly, a lack of liquidity – the company cannot meet its short-term (< 1 year) obligations. Secondly, solvency isn’t able to be maintained – i.e the firm cannot pay its debts. According to the market, CCL suffers from both of these issues (as shown by it’s junk bond status) – however, just because a firm is highly leveraged and doesn’t generate working capital is not enough reason to discard it. It’s worth noting that CCL has never been working capital positive and that’s the nature of the cruising business.
The primary reason for the negative working capital is because cruise operators take customer deposits which is marked as a “current liability” on the balance sheet. If anything, right now, customer deposits is an indicator of demand and a large number of customer deposits is good news for the analyst. This seems to be the case in 2023 as Josh Weinstein – CEO – shared on the Q1 earnings call that already CCL are over 70% booked (for this year).
The trick to this investment is time – I don’t see a catalyst and I don’t think there is one. A quick word on catalysts – truthfully, I don’t think they’re necessary. If a company is clearly undervalued, that’s more than enough reason to invest. Trying to work out what the catalyst might be is a waste of time, in my opinion.
Back to Carnival – the business will have to operate as normal as it can whilst also paying down its debt – basic probability suggests if demand comes back to pre-pandemic levels, CCL will be in strong health in (and around) five years assuming economic conditions are fairly constant (i.e no further lockdowns etc). Right now – the demand is being driven by the UK and Europe. Hopefully, it’s sustained and it spreads across to the USA and Australia.
Most people today in the market are “speculators” – they won’t stick around for five years for a return – and that’s why the CCL share price has been beaten down. The market today is thinking in the short-term (more than usual, anyway). It’s all about survival and “risky” stocks have gotten sold off – though, the flows from investors in recent months have been very questionable (Nvidia is always my go-to example). But my point stands – nobody (including myself) knows what the market could do in the next few months. My feeling is everyone’s (secretly) bearish but the market is non-reactive.
Even if we’re hit with a recession this year (or next), business for CCL will be better than it was during the pandemic years – this much is a given. In fact, recession isn’t bad news at all – I was going through CCL’s annual filings. 2008 was a fantastic year with revenues increasing 12% compared to 2007 and earnings staying flat. What about 2009? Not as great as 2008, but flat revenues compared with 2007 with earnings being hit a little. Ok – let’s go slightly further back. Say – to 2001 (the aftermath of dotcom). Revenues up by 18%, profits down by 4%.
What’s my point? My point here is simple – only a pandemic could really do damage to the Carnival business. Regardless of the economic situation, people enjoy going on holiday, people enjoy different experiences… in short, I think the cruise operators will rise again. Maybe it’ll take a little longer than initial post-pandemic expectations (it certainly seems that way) but patience is key as an investor.
Already we’re beginning to see my point get proven. If we look at Q1 23 results, there is reason to be bullish. Over $4.4b in revenue compared to a measly $1.6b in Q1 2022 with an operating loss of $(172)m – compared with $(1,491)m in the same period in 2022. If we use these results and extrapolate them, you’d see CCL doing over $17.5b in revenue – closer to the pre-pandemic results of $20b (in 2019). Of course, this run-rate isn’t entirely true as the cruise industry is seasonal – but that proves my point further. If anything, they could do better with the third quarter generally being the best (summer holidays).
The other advantage that CCL has it its in better health to its competition. I’ve mentioned in a previous post that the trick was to buy the best of an unwanted bunch. You limit your downside this way – we’re not going to witness every cruise operator file for bankruptcy but it’s possible that the “weakest” one or two do get into serious trouble.
Many of you will know that during the pandemic years, cruise operators suffered tremendously taking on vast amounts of debt and getting hit with losses never seen before in the industry.
The interesting thing about the debt is I don’t see it as “unsecured.” From my perspective, they’ve borrowed their debt against the assets (ships) they already own and should they need to, they could borrow more (though, shareholders probably want this to occur). In my eyes, it’s not too dissimilar to re-mortgaging a property except the value of a cruise ship declines with time (in the form of depreciation on the balance sheet). In the worst case, they can just sell the ship for cash should they need too(which did occur in Q1 2023 where CCL sold one ship for $186m).
Here’s something else worth mentioning – past results are more useful in this industry than they are in technology (for instance). CCL has grown well in the past – with little debt – and provided they get past this “blip” where they look very leveraged and unappetising, their future should be smooth sailing.
Let’s briefly look at NCLH (Norwegian Cruise Lines) – debt/equity is close to 200x. NCLH has a current ratio of 0.3x and you’d be paying over 80x book. It’s not a value stock – it’s speculation. It’s likely NCLH will never get out of a cycle of issuing more and more debt just to continue operations.
Ok – let’s look at more of a competitor then. Royal Caribbean Cruises (RCL). RCL does revenue of close to $9b with a market cap of over $15.5b. Again – there is a debt problem. RCL has a debt/equity ratio of over 8x. Oh – the other problem with RCL? Insiders have been dumping the shares. It’s not a brilliant look.
CCL, however, has debt/equity of 5.7x – still high, but lower than the competition. To counter my point, it’s worth noting that the interest on CCL’s debt is higher. However, overall, a lower claim on assets is better for the investor (in my opinion) and, also, I don’t think the interest in unmanageable. Bizarrely – the market disagrees with my logic. CCL has the highest short interest out of the three companies.
Despite me mentioning the “competition”, I don’t see competition as a threat. Carnival’s name is a moat in itself. This is unlike the airline industry where people choose the cheapest flight. With the cruise industry, you’re paying for an experience and aggressively cutting prices would erode the value of such an experience. Further to my point, cruise operators generally have a niche – Viking River Cruises and Royal Caribbean obviously don’t compete (even though, technically, they’re in the “same” industry).
Here’s another reason to like CCL – between 2013 and 2019, ROE averaged 9.3% and ROA averaged 5.4% with ROIC averaging 6.6%. It’s also worth noting that during that period, debt/equity averaged 0.4 and debt/EBITDA averaged 2.34. My point? They employed little leverage and still delivered consistent returns for investors. These numbers should prove how strong CCL can be in normal market conditions. It also should strike you that CCL can come back fairly quickly if these numbers can be achieved again.
The management team at Carnival is competent, in my opinion – they’re realistic and, if anything, under-ambitious with their targets. I also agree with management’s targets – they want to accelerate the paydown of debt and they want to generate free cashflow. Why? Management want to return to investment grade and I can’t see an issue with pursuing a goal like that.
I don’t actually have too many concerns with this investment. It’s purely logical and I’ve invested into Carnival as of 25/04/2023. I don’t expect to see a significant return very quickly and I don’t think I’ll even bother looking at the share price in the next six months. I also think the industry will experience tailwinds, NOT the headwinds that the market seems to assume. All in all, relax and enjoy a long cruise – provided you can tough out a bumpy beginning.
Best investing,
HV
