June 9, 2020
Covid-19 has brought the world to a standstill resulting in heavy travel restrictions with planes grounded and ships docked. As travel companies face the threat of going into bankruptcy, what does this mean for the cruise industry? Carnival, the world’s largest leisure travel provider has been among the most sought-after stocks. Their shares have been trading at a discount of over 60% since soaring in January, with over 10 million shares being traded daily. Carnival has seen its valuation decline severely within the last 5 months, what does this mean for investors?
Some of the consequences of the pandemic include a complete halt in operations, along with port and lockdown restrictions, which has meant that the business has had to issue refunds to all customers who signed up for cruises in the coming months, further impacting cash flows. Carnival is losing approximately $500 million each month just to stay afloat but plans to start sailing their ships again as soon as August, with customers still making bookings.
Carnival has a strong historical track record, with their annual Return on Equity (ROE) between 2017 - 2019 beating the industry benchmark of 10% each year. So the negative yield for their ROE in Q1 of 2020 shows that the cruise company has been badly impacted. Here we compare it with the yield from the same quarter in previous years.
Another important metric to consider is the Return on Invested Capital (ROIC). The ROIC is a measure of profitability and efficiency, evaluating whether a company is using invested funds to generate income for the business.
Carnival’s ROIC has seen positive returns of over 3% since 2018. Generally speaking, companies that generate an ROIC over 2% indicate that management is fully utilising shareholder investments to generate funds efficiently. The company has generated continuous positive net income since 2015 and has continued to make profits up until the latest quarter.
Can a highly profitable company withstand the impact of Covid-19? Carnival will only begin seeing profits when ships start sailing again. But that may take some time as travel restrictions are being heavily enforced and customers will be reluctant to travel, even after this pandemic subsides.
The company has suspended dividend payments indefinitely as of March 2020, to improve liquidity and meet long-term debts. A move which will help Carnival to survive the impact of Covid-19.
Just how cheap is Carnival’s share price compared to its main competitors right now?
Compared to the industry benchmark of 10x, Carnival’s ROE is relatively low. In the case of Royal Caribbean Cruises, a 88.5x P/E ratio during this pandemic is not only unrealistic, it means that the stock price is high relative to its earnings and undeniably overvalued. Investors are willing to pay a high price for Royal Caribbean Cruise shares partly due to the fact that the company has not cancelled its cruises for the whole of June, as this is a sign of inbound income. As for Norwegian Cruise Line, a negative P/E ratio indicates that the company is losing money and also, it has not announced a robust plan to stay afloat, making it a less attractive investment for value investors.
Out of the big 3 cruise companies, Carnival’s PE ratio is the most realistic given the current circumstances and has the best bang for buck in terms of valuation within this industry. So investors might want to capitalise on the fact that the company is trading at a 60% discount. Carnival’s share price has been increasing over the past 2 weeks even though all of its ships are still docked. This could be a sign that investors are confident that the company will prevail over this pandemic.
From a qualitative standpoint, Carnival has successfully raised 6.25bn in debt and equity to fund its ongoing operating expenses. With funds of $6.25 billion divided by its $500 million monthly burn rate, Carnival has sufficient funds to stay afloat for the next 12.5 months, with hopes of business starting up again as soon as possible. Those cash flows along with an increasing share price, mean that Carnival is looking bullish.
In addition, the Saudi Arabian Public Investment Fund (PIF) has recently purchased an 8.2% minority stake in the company, a rare sign of investor confidence in an industry severely affected by COVID-19. The PIF which invests domestically and abroad, has previously also taken a 5% stake in Tesla and Uber. With such a huge investor backing Carnival, there is a reduced possibility of the company going out of business. Despite customers staying clear from travelling, cruise bookings for August have soared 600%, as megadeals are being advertised to attract the younger crowd who would normally be unable to afford the pricy fares. The lower prices are in line with Carnival’s new strategy to appeal to customers of all ages, with hopes to stimulate business and growth.
Taking into account both quantitative and qualitative factors, Carnival ranks the highest against its other two main competitors as it has the best quality and value ranking. In these uncertain times, it is difficult to say whether Carnival will be able to begin cruises in August. But the company has enough funds to keep them going for longer if necessary. Once they’re back on course, Carnival which has 50% market share in the cruise industry, is looking to expand this position with another 4 ships currently being built. If you are looking to invest in the cruise industry, Carnival is worth considering.