In May of last year, I believed that it was time for Carnival Corporation & plc (NYSE:CCL) to leave port, and with that I meant the business, certainly not its shares which performed actually too well in my opinion.
The company was preparing for a reopening of the economy, with liquidity being bolstered as pent-up demand might result in a peak in profits. Despite the near term potential, I believed that the enterprise valuation has risen too much from pre-pandemic levels, even as shares have been lagging, with Carnival having incurred some dilution and a lot of debt.
Carnival has been one of the businesses which has been hit the largest by the pandemic, creating no sea for smooth sailing. While the economy was on the verge of reopening in spring/early summer last year, I simply was not seeing the potential.
To understand where Carnival is coming from, we have to look at 2019 as a base-case year. That year, Carnival posted $20.8 billion in revenues on which it posted operating earnings of $3.3 billion, net earnings of $3.0 billion, and earnings of $4.32 per share based on 692 million shares outstanding. Net debt of $11.5 billion looked steep in relation to earnings power, but should be seen in the light of the ships being carried at a $38 billion valuation on its books.
The book value of equity of $25 billion in 2019 stood in comparison to a market value of $5 billion at a low of $8 per share in 2020, as investors are expecting huge cash outflows and write-downs on the assets. The company sold shares and incurred a lot of debt in the meantime.
The 2020 results were awful, as was no surprise with revenues down to just $5.6 billion on which an $8.9 billion operating loss was posted, including some $4.3 billion in depreciation and goodwill charges. This resulted in huge dilution and debt absorption, not only impacting the potential of the company for survival, but also liming the upside in case of a recovery.
First quarter sales in 2021 came in at $26 million, and that is no typo, on which $1.5 billion in operating loses were reported. Despite the potential for a recovery amidst the reopening of the economy, the share count has risen to 1.1 billion shares, revealing some 50% dilution from the get go of the pandemic.
At $27, the equity value rose to nearly $30 billion, with net debt having doubled to $20 billion, for a $50 billion enterprise valuation. The ironic thing is that the 692 million shares in 2019 valued the company at $28 billion at $40 per share, yet with net debt around $10 billion, the enterprise valuation has risen by more than $10 billion since that period of time, while the company is arguably in worse shape.
I expected that investors were betting on huge near term earnings following the reopening, making it a dangerous short, yet leaving me extremely cautious based on the fundamentals.
Reopened – Shares Are Sinking
Despite the reopening of the economy, shares of Carnival have been moving lower again, now trading below the $10 mark, as shares are down some two thirds from the $27 mark in May of last year.
Early in 2022, the company posted its annual results for 2021, which were detrimental. Full-year revenues fell from $5.6 billion to $1.9 billion, just a tenth of the normal 2019 run rate, although fourth quarter sales came in at $1.3 billion already. Full-year operating losses totaled another $7.1 billion, as fourth quarter losses of $1.9 billion were steep, despite the reopening of the business again. Following large interest expenses and debt extinguishment costs, net losses of $9.5 billion were largely similar to 2020.
In March, the company posted first quarter results as sales recovered to $1.6 billion, yet operating leverage is detrimental as a $1.5 billion operating loss was flat compared to the same quarter a year ago. In the meantime, more dilution has been incurred as the shares count has risen to 1.14 billion shares, while net debt inched up to $28 billion. With shares still trading at $20 earlier this year, that still translated into a very high valuation in excess of $50 billion.
In June the company issued a somewhat upbeat second quarter guidance with revenues up 50% from the first quarter as revenues indeed did come in at $2.4 billion based on occupancy levels of 69%. The issue is that net losses are still seen at $1.8 billion after an operating loss of $1.5 billion, as the impact of high debt is certain very toxic environment for the company, essentially leaving all the cards open.
By now the company was forced into another freaky move, as the company sold 102 million shares, essentially at a tenth of the equity of the business at $9.95 per share, raising gross proceeds of around a billion. While this results in 10% dilution, it reduced the net debt load by just a billion, just over 3% of the existing net debt load, thereby hardly making a dent.
For me Carnival remains a very dangerous company, and while I do not advocate a short position, I would stay away from the shares here. Even now we are still dealing with a $40 billion enterprise valuation, as operating leverage is not really seen, with losses coming in flat despite revenues slowly picking up again.
Even if Carnival could deliver on its 2019 results again, with operating profits posted north of $3 billion on $20 billion in sales, net earnings would only come in around a billion, after taxes and interest rates. All of this makes me very cautious, as this results in potential peak profits of less than a dollar per share, or perhaps a dollar if all goes well, leaving no real potential as we are far removed from achieving such results.
With the pandemic potentially on the retreat, high fuel costs and labor shortages hurting the business, this stock is very easy to avoid, as I am kind in expressing these words.