Carnival Corporation Shares Are Mispriced

It has become truly boring to read about the cruise industry because every analysis point to the same conclusion; this industry will continue to suffer and the recovery is years away. Beat Billions, however, begs to differ. Our regular readers should not find this surprising because we’ve been publishing about contrarian investment opportunities consistently in the last few weeks., and we added Carnival Corporation & Plc (CCL) stock to our watchlist of stocks that we believe would generate double-digit, if not triple-digit, returns in the coming years. Our investment thesis for CCL stock is based on three pillars.

Pillar 1 – consumers want a way out

One would assume that consumers across the world are huddled up in their homes praying for a pharmaceutical company to come up with a vaccine to curb the spread of the virus. This might be true, but what is also true is that people would go to extreme lengths to be entertained!

Take a look at the reopening of the Shanghai Disneyland today. Disney was requested by the Chinese government to operate at a capacity of not more than 30% or a cap of 24,000 people per day. And here comes the surprise. The tickets were sold out within just a few hours of making this announcement! This is a clear indication that park-goers are itching to get back to theme parks despite the absence of a cure for the novel coronavirus.

It’s reasonable to assume that things will be the same with voyages as well. In fact, there is data to suggest that this is indeed the case. For instance, Carnival announced on May 8 that it will offer some cruises in August. With this announcement, bookings surged by a staggering 600% compared to the previous 3 days and were up more than 200% in comparison to the same time period in 2019. Carnival is yet to obtain the approval of the CDC, but investors can see where we are going. As soon as mobility restrictions are eased, Carnival’s ships would be out in the seas carrying a record number of passengers.

Interpreting this surge in demand could be a tricky task. The industry serves many 60+ individuals and it’s reasonable to believe that these consumers will likely not want to be in a ship for the next few months at least. However, the data we have suggests otherwise. This is probably due to the fact that people are already searching for a way out of this toxic environment.

Taking these developments into account, Beat Billions believes that the demand for the cruise industry will recover faster than many analysts are factoring into their models. This, on the other hand, will lead to positive earnings revisions for 2021, substantially improving the investor sentiment toward Carnival shares.

Pillar 2 – liquidity concerns are overblown

The expected liquidity concerns are keeping many investors on the sidelines. However, we believe Carnival will do just fine. For now, we believe that trying to model Carnival earnings to gauge a measure of the intrinsic value of Carnival Cruise stock is a futile task as there is no doubt that Carnival will take a massive hit to both revenue and earnings. Rather, the focus should be on the cash flow profile of the company to determine if Carnival can weather the storm and remain solvent until business activities return to normalcy. If this happens, Carnival shares will deliver stellar returns to long-term investors as the industry dynamics are favorable for the next 5 years.

Here is our take on liquidity.

Carnival raised $5.75 billion by issuing new debt in April and another $500 million by issuing equity. These funds will help the company survive 2020 even without incorporating any new revenue. However, the company will most likely bring in revenue in the fourth quarter of this year. Even under the worst-case scenario, Carnival has sufficient liquidity to survive the crisis. At present, the company holds $9.75 billion in cash. Going by the guidance of the management, Carnival will incur maintenance costs of around $300 million per month. We can assume the company will be forced to refund around $2 billion to customers who had made bookings for cruises this year, as the company now has to cancel these bookings. To add to this, the company is expected to repay around $2 billion in debt this year as well. Annual interest costs come to around $500 million. Taking all these into account, Carnival would need $6.65 billion to survive this year. In contrast, the company already has over $9 billion in cash in hand, which confirms the company is in a solid position to survive the crisis and come out stronger in 2021.

With liquidity concerns out of the equation, we can establish the fact that Carnival will survive this downturn and remain solvent to see light at the end of the tunnel.

The next step, therefore, is to determine whether Carnival shares are cheap.

Pillar 3 – shares are undervalued

Carnival shares are down 73% for the year, and it seems as if Mr. Market is betting on the company to go out of business sometime soon. Carnival shares have traded at a 5-year average P/E of 16.43, in comparison to the depressed earnings multiple of around 5 today. This alone, however, is not an indication of shares being undervalued.

There’s reason to believe that Carnival shares will converge with its historical multiples, at least partially, in the coming months. Many of the negative developments are already factored into the market value of the company, whereas Beat Billions expects positive developments to materialize in the next few months, sending the shares higher.

In the long term, Carnival shares will follow the earnings of the company, similar to any other company. The favorable macro-economic outlook resulting from the expected economic growth in 2021, increasing personal disposable income in many regions of the world, and the number of young millionaires, will act as catalysts to help Carnival improve its earnings in the next 5 years.

Takeaway: Carnival shares will help you “beat billions”

Beat Billions aims to find small-cap stocks that could deliver alpha returns over large-caps. With a market capitalization of $10 billion-plus, Carnival is not necessarily a small-cap stock. However, this company fits our description of an investment that could deliver stellar returns to investors in the coming years. At the end of the day, we don’t invest in small-cap stocks just for the sake of doing so. The underlying thesis is that small-caps will grow faster, delivering comparatively better returns.

Based on a three-pillar thesis, we believe Carnival shares are significantly undervalued. An improvement in the sentiment of investors toward CCL stock is on the cards as well, leading to attractive returns in both the short and long-term.

The author of this article is long CCL.

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