Carnival sailing on thinning liquidity

The cruise operator’s Diamond Princess made nightly headlines around the world after infections spread through the ship, which Japanese authorities quarantined in the port of Yokohama for three weeks. At one stage, more than half of the world’s confirmed cases outside China were on board and 13 passengers died.

Elsewhere, Carnival cruise lines faced problems getting people back to dry land after some countries refused entry to ports for fear the ships were carrying infected passengers.

The Miami-based firm, whose shares have been dual-listed in the US and the UK since it bought P&O Princess Cruises in 2003, had started 2020 on a wave of optimism. It forecast growth rates of 4.5 percent a year through 2025, but its share price fell 74 percent in the first quarter after the U.S. Centers for Disease Control halted all cruises — a measure that kept it in effective until July 2021. Most other countries followed suit.

Standing up

Carnival entered the pandemic as the world’s largest cruise operator, with 104 ships. In the year ending November 2019, it carried 45 percent of all cruise passengers on its nine lines – including Carnival, Holland America, Princess, Costa, Cunard and P&O.

Overhead was also high, with operating costs coming in at $17.5bn (£14.81bn). Despite starting a series of redundancies, redundancies and pay cuts in May 2020 to reduce cash burn, the group still suffered cumulative pre-tax losses of nearly $20bn (£17bn) over the past two years.

But beyond the collapse of its market, Carnival’s main problem was that it had committed huge sums to finance new ships. From the end of November 2019 to May this year, the company spent $8.4 billion on new ships, as well as $2 billion on ship upgrades and replacements, IT systems and other capital expenditures.

It has stayed afloat only by exploiting the capital markets for large sums of money. In the 36 months to May, the firm issued more than $30 billion in debt and raised $4 billion from equity investors. Another $740 million was recovered through ship sales.

Carnival suffered a net cash outflow of $1.9 billion in the six months to May, but with most of its fleet back on the water and demand for bookings rising, management has signaled the worst is over.

Indeed, the phrase “inflection point” was used three times during an interim earnings call on June 24, after outgoing CEO Arnold Donald noted that cash flow from operations had turned positive during the second quarter of the year.

At that point, cruise capacity was at 91 percent of pre-pandemic levels and occupancy rates were heading toward 80 percent. Booking volumes for future cruises were also up: second-quarter bookings for all future cruises were at their highest level since the start of the pandemic, though still below pre-pandemic levels, Chief Financial Officer David Bernstein said.

The company still posted a net loss of $3.7 billion for the first half, only slightly better than the $4 billion loss recorded a year ago. Bernstein blamed the additional costs of taking ships to sea, higher inflation and the costs of meeting stricter health and safety protocols, but estimated that adjusted earnings before interest, taxes, depreciation and amortization (ebitda) would return positive during the current quarter of the company. “which after all we’ve been through will be something worth celebrating.”

Even this low level is not a given, however, given the weight of inflation. While a more than doubling in volumes accounted for most of the more than tripling of fuel costs in the first half to $910 million, a 79 percent increase in average fuel prices hardly helped.

Payroll costs also doubled to $1.04 billion and although the company said it was “making progress” in resolving staffing challenges, both Princess and P&O lines have had to cancel voyages in recent months due to shortages the staff.

Cost pressures mean analysts are much less confident about Carnival’s near-term prospects, especially as it chooses not to buy fuel hedges, unlike peers.

UBS cut its price target on Carnival shares from $23 to $12 last month, with higher fuel prices accounting for about $8 of its cut and higher interest changes for another $2.

Meanwhile, Stifel cut its 2022 ebitda forecast from $103 million to a loss of $244 million and cut its price target by a third to $20, arguing that near-term weakness masks what its analysts see as a trade “unbelievable” long term. Indeed, although shares are down 48 percent year-to-date, their recent rally suggests the investment bank may be right when it suggests long-only investors are buying ahead of a general cash flow.

Picking up speed

As Stifel notes, investors have two near-term concerns: the sustainability of current reserves in a deteriorating consumer outlook and debt. In the first, the bank believes that booking patterns are “largely healthy” and that tight labor markets and high savings rates mean that any looming recession will be atypical. Last week, Carnival Cruise Line said its daily booking rate doubled after updating its policy to accept unvaccinated guests if they can present a negative PCR test.

How much demand continues if the state of the economy turns more dangerous is a key issue, given Carnival’s reliance on the North American and European markets. Together, these accounted for 85 per cent of 2019 and 98 per cent of FY2021 revenue, thanks to ongoing closures at many Australian ports. Two consecutive quarters of contraction in US gross domestic product and fears of winter energy shortages on both sides of the Atlantic have some economists predicting deep recessions.

Morgan Stanley cut its target price on the shares to 575p at the end of June. If the industry faces further demand shocks, its analysts think equity investors could face extinction.

The main concern is liquidity. While the $7.5 billion available at the end of May may seem like a large number, future commitments are also large. Capital commitments total $5.6 billion and $4.3 billion this year and next, respectively, interest payments alone are coming in at $1.6 billion a year, and as of May, $4.1 billion of debt was set to mature by the end of 2023. Some ship sales have helped, but the trade-off is a cut from the long-term sales growth target of 2.5 percent.

Berenberg thinks that even if the second half swings to profitability, Carnival will have burned through $3.2 billion before this year and $5.5 billion by the end of 2023. That would mean pulling part of the $2.7 billion revolving credit facility. , which also expires in 2024.

“To restore the balance sheet to an even level, we estimate that Carnival will need to secure $3 billion in long-term financing,” the bank’s analysts wrote recently.

And while the average interest rate on Carnival’s debt is about 4.5 percent, the 10.5 percent coupon attached to May’s $1 billion unsecured bond offering shows that debt investors are drawing red lines. S&P Global has assigned Carnival a “B” debt issuer rating — below investment grade — with a negative outlook, while Morningstar analysts interpreted July’s $1 billion capital raise as a sign that “the debt growing at the moment is becoming extremely expensive”. .

Few expect capital markets to abandon the company entirely, but if appetite for corporate debt weakens as interest rates float higher, it will be equity investors that Carnival will once again turn to as it looks for a way out. the storm