Carnival seeks calmer waters with $1bn fund raising

“Dr. Evil, nemesis to Austin Powers, was never quite sure whether one billion dollars was a lot of money or not as he planned his villainous campaigns, but shareholders in Carnival seem pretty certain that it is,” says AJ Bell Investment Director Russ Mould. “Shares in the cruise ship operator are sinking as it looks to raise that sum by selling just over 100 million shares at $9.95 apiece - around 830p at current exchange rates.

“The fund raising, which looks a little opportunistic given the pop in the share price from June’s multi-year low of 620p to just shy of 800p a few days ago, is presumably designed to help support a balance sheet which looks a little leaky.

“Net debt, including leases, of $29.2 billion compares to shareholders’ funds of $8.3 billion for a gearing ratio of 353%. A business with relatively predictable demand and stable cash flows – such as maybe a utility – would be suitably placed to withstand such a burden, but a company that depends on discretionary consumer spending and has fuel as a major input cost is a much riskier proposition.

“To see its way through the pandemic and lockdowns, Carnival sold and leased back vessels or took on debt.

“The result is that the balance sheet looks stretched, and the company’s valuation (on the basis of enterprise value) is not much cheaper than it was pre-pandemic despite a 78% fall in the share price and an increase in the risks associated with the company.

Source: Carnival company account

“At the time of the full-year 2019 results in December of that year, Carnival had $518 million in cash and $11.5 billion in borrowings for a net debt position of $11 billion. Shareholders’ funds (or equity) of $25.4 billion meant that the gearing ratio was just 43% and $3.3 billion of operating profit covered net interest payments by a more-than-comfortable 18 times.

“After two-and-a-half years of strife, the second-quarter results for 2022, released in June, show $7.2 billion of cash at hand but borrowings of $35.1 billion and leases of $1.2 billion to give that net debt position of $29.2 billion.

“Heavy losses have eaten into shareholders’ funds, so the combination of lower net assets and higher borrowing has in turn driven up the gearing ratio to 284%. And even if operating profit does return to 2019’s $3.3 billion level in 2023, as analysts currently expect, that would only just cover the last annual $1.6 billion interest bill by a factor of two.

“From a valuation perspective, Carnival stock is not markedly cheaper than it was in 2019, once you run an Enterprise Value analysis.

“As of the close on Wednesday, the shares were down by 78% since December 2019. But the enterprise value - market capitalisation, plus net debt, plus leases, minus cash and liquid assets - is only down by 9% because of the increases in debt, leases and in share count after an earlier capital raising.

“In 2019, Carnival had 692 million shares in issue and the share price was $50.21 when the results were released that December, for a market cap of $34.7 billion. Add on the net debt position of $11 billion and the company had an enterprise value of $45.7 billion.

“Before the planned sale of 102 million new shares, Carnival has 1.14 billion shares in issue and Wednesday’s closing share price of $11.09 gave a market cap of $12.6 billion.

“But with net debt soaring to $29.2 billon, the enterprise value is now $41.8 billion, so the enterprise value is only 9% lower than it was two years ago, even if the company’s finances have weakened and the outlook for the cruise industry potentially changed because of energy costs and growing concerns over consumers’ ability and willingness to spend.

“Granted, Carnival has more than $7 billion in cash at hand plus additional borrowing capacity to see it through, and the firm is expected to lose ‘only’ $2.9 billion in the twelve months to November 2022 compared to $9.5 billion in fiscal 2021.

“However, any delay to anticipated profit recovery could drain away some of that cash and Carnival’s management may therefore be sensibly preparing for further difficulties ahead.”