One company that has been hit harder than almost any other business in the pandemic is Carnival Corp. (CCL, Financial). Formerly the world’s largest cruise ship operator, the group was forced to shut down almost overnight when the pandemic began.
Over the past two years, the company’s reported revenues say more about the scale of the decline than words ever could. For the quarter to the end of August 2019, Carnival reported revenues of $6.5 billion and an operating profit of $1.9 billion. For the same quarter in 2020, revenues totaled $31 million with an operating loss of $2.3 billion. That was a revenue decline of 99.5%.
To put it another way, for the quarter to the end of August 2019, the company generated a revenue return on shareholders' equity of 26%. A year later, the figure was 0.16%. The yield on the 10-year Treasury in August last year was around 0.50%.
As we near the second anniversary of the start of the pandemic, Carnival is starting to recover. Revenues for the quarter to the end of August 2021 had recovered to over $500 million. That is still far off the $6.5 billion reported for the same period two years ago, but it shows the business is moving in the right direction.
However, looking deeper into the numbers, it becomes clear that the business is still struggling. This is particularly evident on the company’s balance sheet. Already in boatloads of debt before the pandemic, the company had to issue bonds often with interest rates of 10% or more in order to raise enough debt to survive, and that will serve as a lodestone to growth for many years to come.
A company that is struggling
Shareholder equity at the end of August 2021 totaled just under $14.9 billion compared to $17.9 billion for the quarter to the end of May. Lower levels of cash on the balance sheet, a fall in the value of its long-term assets and a higher level of debt were all factors that contributed to a lower shareholder equity figure at the end of the period.
The company’s future is tied to the course of the pandemic. If it continues for the next few years, it seems likely that consumer confidence will remain depressed. This will certainly have an impact on Carnival’s revenue growth. Even if consumer confidence recovers, there is no clear path for the company to return to 2019 levels of profitability.
The group’s balance sheet illustrates the damage the pandemic has caused to the business. Debts have ballooned and so have debt interest costs.
There is also no guarantee that the value of Carnival’s assets, mainly its ships, is still reliable. If the cruise industry never recovers to 2019 levels of activity, or takes so long to recover that Carnival has to further scale back operations, then the industry will be oversupplied with vessels. This will hit values in the second-hand market. The industry is already plagued by overcapacity. Anyone can look online today and find deeply discounted voyages. Companies are desperate to get buyers back, even if they have to sell at or below cost. If demand takes too long to recover, new players with lower debt could potentially swoop in and buy steeply-discounted vessels from the struggling cruise companies.
The problem of valuation
Warren Buffett (Trades, Portfolio) has said that the best way to value a business is to look at the cash flows from now “until judgment day.” To do this, investors need to have a certain level of certainty that the cash flows are reliable and predictable.
When it comes to Carnival, it is impossible to estimate how the company’s cash flows will develop over the next five years. It seems unlikely they will recover to 2019 levels considering the state of the industry and the pressures on the group’s balance sheet and income statement.
On top of these factors, the stock lacks asset support. At the time of writing, the shares are trading at a price-book ratio of around 1.6. That looks expensive to me. What’s more, there is no guarantee book value is worth what the company says it is as the asset values may be marked down significantly in the second-hand market. Then one has to consider the recent trend in shareholder equity. It has been shrinking. Buying a stock at a discount to book does not mean much if book value keeps falling.
Therefore, while Carnival shares might look cheap compared to their trading history, the company’s value is almost impossible to calculate. It looks more like a value trap than a value play to me.
