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With the current bull market looking more and more like a chapter out of Charles MacKay’s classic book, Extraordinary Popular Delusions and the Madness of Crowds, it’s no surprise that value investors are finding the pickings slim these days. But there still may be one pocket of undervaluation worth exploring: holiday cruise companies.

While shares in many travel-and-leisure companies are now trading above their pre-COVID-19 levels thanks to the rollout of vaccines and glimmerings of an economic upturn, the same cannot be said for cruise liners. Their stocks haven’t gone up as much and are still trading 25 per cent to 50 per cent below pre-COVID-19 levels. The three largest companies by market capitalization are:

  • Carnival Corp. (CCL-N, also listed as Carnival PLC on the London Stock Exchange);
  • Royal Caribbean Cruises Ltd. (RCL-N);
  • Norwegian Cruise Line Holdings Ltd. (NCLH-N).

Can their share prices return to their pre-COVID levels? If they do, the price gains would range from 33 per cent to more than 100 per cent. But the sector was one of the hardest hit by the pandemic and it could take a while. Risks to the downside are material too. Buyers may have their patience and risk tolerance tested.

Since the outbreak of COVID-19, cruise ships operating from U.S. ports have been under a “no-sail order” imposed by the U.S. Centers for Disease Control and Prevention (CDC). The sailing ban has slashed cruise revenues to a trickle and turned earnings into an ocean of red ink, as can be seen in their financial statements.

Take Carnival, the largest operator with more than 100 ships. Its revenues have tumbled by two-thirds to US$830-million during the 12 months to Feb. 28 (the end of the first quarter). Net income has plunged, to a loss of US$11.4-billion.

Negative cash flow, or “cash burn,” is significant. Carnival’s cash burn, on an average monthly basis, is US$530-million; for Royal Caribbean it’s US$270-million; and for Norwegian Cruise Line, US$170-million. On a per ship basis, Norwegian Cruise Line is burning the most cash.

The good news is that the three companies have been able to buy time for a turnaround by selling about 10 per cent of their ships, issuing shares and floating bonds – to raise US$40-billion in capital. After covering some continuing costs, much of the new capital sits on their balance sheets.

Carnival, for example, has cash and short-term investments of US$11.5-billion. This provides funds to carry on into 2022 even if no revenues are coming in, as chief executive Arnold Donald told the Financial Times of London in March.

On top of this, the CDC announced in late April an easing of restrictions, effective this summer. One proposal would allow ships to launch if the crew and passengers are sufficiently vaccinated.

Advance bookings are also accelerating. Carnival’s first quarter saw a 90-per-cent jump in booking volumes over the previous quarter. Indeed, reservations for 2022 departures are coming in even stronger than they did for 2019. As Carnival’s chief financial officer David Bernstein said during a conference call with investors: “There’s all that pent-up demand.”

So, there is some potential for the news flow to deliver positive surprises, which could boost share prices. But let’s not get carried away: There could also be some negative surprises.

The new capital that has allowed the cruise liners to stay in business has also raised performance hurdles. For a start, share dilution and smaller fleets will make earnings-per-share targets more of a challenge.

The larger debt load has also turned the companies’ investment-grade credit ratings into “junk” status, elevating solvency risk. For Carnival, interest payments were US$1.2-billion in the 12 months to Feb. 28, up from US$200-million in 2019.

Whenever the industry is allowed to return to open waters, it may take several months to get ships and crews ready. For example, Mr. Donald said Carnival has 90,000 employees to bring back to work, spread across several countries with different COVID-19 conditions and rules.

Valuation is rich. According to data on analysts’ earnings projections, current stock prices for the three companies are trading more than 50 times higher than consensus 2022 earnings estimates.

In summary, there is a potential for positive surprises in months ahead that aggressive investors may want to capture. However, others will not have the patience or the capacity for riding out the volatility. Another deal breaker could be the solvency risk. It may not be overly pressing but with debt and cash burn so high, it cannot be ignored.

Special to The Globe and Mail

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