LONDON: Carnival is an oddity. The London listing of the Miami-based cruise line operator is a legacy of its 2003 hostile takeover of P&O Princess Cruises, which it won on a pledge to be dual-listed.
The stock also stands out as the FTSE 100’s biggest faller in the year to date, down more than 60 per cent.
Last week, the aggregate value of Carnival’s UK and US lines was £2.5 billion (US$3.2 billion) lower than when the P&O takeover took effect almost 17 years ago, when the combined fleet was 62. It is now 104.
Judging whether this sell-off is an overreaction demands answers to two key questions: How long it will take for coronavirus to be brought under control, and what will be left of the industry when that moment comes.
Until that becomes clear there is no possibility of anchoring forecasts and calculating future values. Investing becomes gambling. And, as these two weeks’ record-breaking falls show, most investors are reluctant gamblers.
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The viral outbreak has become an existential crisis for the industry. Carnival’s competitors have fared even worse so far this year, with Wall Street-listed Norwegian Cruise Line and Royal Caribbean each down about 80 per cent.
Cruises have been targeted because no sector looks as poorly positioned to cope. The disease has spread through the winter “wave season”, the industry’s key quarter when ship owners race for early bookings so they can at least break even for their year’s scheduled sailings.
Demand and capacity are often hard to match as ships are typically delivered up to five years after ordering and have price tags with nine figures.
Then there is the much-discussed problem of demographics. About one in seven cruise ship passengers is over 70, putting them in the highest risk category for COVID-19.
After decades of stories about outbreaks of norovirus, the operators already had a poor reputation for keeping them healthy.
A COVID-19 case on Carnival’s Diamond Princess is used by epidemiologists to benchmark incubation rates, having resulted in 700 infections and eight deaths.
Carnival last week announced it would suspend for two months all sailings under its Princess brand, which accounts for about a fifth of its fleet and targets older holidaymakers wanting longer tours.
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While the action should protect the Princess brand from further damage, it may not help the long-term viability of its product.
POSTPONING THE PROBLEM
One certainty is that 2020 is a write-off. Booking cancellations were reported to be running at around 50 per cent even before Italy’s nationwide lockdown and the US’s ban on incoming European travel.
Offers of big discounts on future bookings have allowed operators to keep hold of customers’ deposits, delaying any crunch on working capital. But increasingly generous terms and flexibility in the customers’ favour could be storing up cash flow problems for later.
US president Donald Trump has talked in vague terms about state assistance. Even if cruise line operators are somehow treated as too big to fail, it is not obvious why they are candidates for bailouts.
Carnival’s debt covenants, in common with its main peers, are framed mostly around balance sheet values.
Eroding these buffers would take deep writedowns of equity value and significant losses over several years, which does not look very likely, as managements move into cash protection mode. There may well be failures among the smaller, weaker players.
But that would make an already cartel-like industry even more concentrated.
In 2016 Macquarie estimated a replacement cost for Carnival’s fleet of nearly US$54 billion, more than twice the company’s current shrunken enterprise value of just over US$21 billion.
In any assumption other than an L-shaped recovery, the risks of failure are not yet that extreme.
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IS THIS GAMBLE WORTH TAKING?
So can a valuation argument be built around those facts alone? Potentially — with the caveat that everyone to try so far has regretted it very soon after. The first quarter has been one that proves the dictum that no matter how bad things are, they can always get worse.
For some, however, it looks like a gamble worth taking. James Hardiman, analyst at Wedbush Securities, says that while his targets for the stock “feel somewhat like an exercise in futility”, there is logic behind them.
“If these companies do not go out of business, they will most likely double or triple in value over the course of the next 12 to 18 months,” he wrote in a report last week. “While speaking in these terms is understandably nauseating to some investors, others will eventually see this as a big moneymaking opportunity.”
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