Will Carnival’s issuance of more bonds help it stay afloat?

(Sonia Ruan Ye, Koushik Karthikeyan)

Cruise lines have been hit hard, with bookings and earnings estimates dropping along with the stock. The pandemic has basically shut the cruising business with cruise companies suspending some if not all of their operations. According to Jacqueline Ceren, the President of Travel Consultation & Mediation Inc. who has been through SARS, Ebola, swine flu, and bird flu, she has never seen anything like this in the history of the travel business.

Cruise companies have seen it all and they have still mostly bounced back after every major crisis. Nevertheless, some experts say this crisis is different. For instance, the government has effectively temporarily canceled an entire industry. So the question is: will the global cruise business bounce back like it’s done countless times before or is this the end of cruising as we know it?

S&P 500 – Carnival (CCL) over the years

Before the COVID-19 outbreak, 2020 was expected to be a record-breaking year for the cruise business with over 32 million passengers, almost twice as many as in 2019.

Carnival Corporation, like other travel and holidaymaking businesses, has faced the full brunt of coronavirus. The world’s largest cruise operator had to halt all of its fleet after the virus broke onto several of its ships and authorities urged the cruise sector to stop operations due to the pandemic. In particular, Carnival had negative headlines after multiple passengers and crew among its Diamond Princess ship caught the virus, with some even dying. Because of that, Carnival stock plummeted 74% as of March 31st, putting the valuation of the company at a multi-year low. Due to all the uncertainty, the company cannot predict if the business will survive. In April, it already sold $4bn of secured bonds with an interest rate of 11.5% (an interest rate typically seen in the junk bond market) backed by collateral and by the company’s assets, including 83 of its ships.

The notes sold this week are secured against its ships but are junior in ranking to the other bonds and loans raised earlier this year, meaning they have lower priority of repayment in case of bankruptcy or liquidation of assets. The sale of these bonds to institutional investors are to the value of $775m and €425m, for maturity in February 2026 and with the offering closing on July 20. The dollar notes have a 10.5% annual interest rate and the euro notes have a 10.125% annual interest rate and will pay their bondholders semi-annually.

Unlike other outbreaks, this one is altering all the industries worldwide, especially the travel industry. However, Carnival is hoping that these cash injections will help it survive and recover from the COVID-19 crisis. Additionally, the deal caught great attention from investors. According to Christopher Yanney, founder at CKC Capital, “Carnival is perceived as a leader and if they are able to make it into mid-to-late next year then this cash gives them a real chance of . . . seeing the other side.”

Outlook

Unfortunately, cruises will be the last sector in the travel industry to recover, because of the nature of being in a confined space for multiple days and the inability to create a safe ‘bubble’ for passengers and staff as a major selling point for these companies is the ability for customers to get on and off the ship and explore various destinations. Furthermore, with the varying stages of lockdown(s) between countries, coordination of safe and manageable routes that Carnival and its subsidiary ships can offer will be hard, as they open up their fleet. This will cause logistical problems, which will not only hurt their business and the sector as a whole, but will also provide a hit to their balance sheet.

However, Carnival has the best profile out of all the cruise lines to survive Covid-19. It has the largest market share, with many subsidiaries such as AIDA cruises and P&O cruises in countries like Germany, Australia and Britain. This makes their business global, meaning they can combat the discrepancies in the stages of the pandemic between regions. For example, authorities in Germany have relaxed restrictions on cruise travel from August onwards and as a result AIDA had over 1000 bookings in a single day, selling its first sailing. Additionally, cruising is likely to start soon in Italy, which will kickstart another subsidiary of Carnival, Costa Cruises. Nevertheless, Carnival’s biggest market, America, looks set to be closed till mid september, meaning the bulk of their revenue will stay missing for an extended period of time.

Financially, they had a current ratio of 0.23 from the financial year ending on November 30th 2019 which will have worsened into 2020 as a result of the pandemic. This low value is worrying, especially in terms of short-term liquidity. Nonetheless, Carnival have addressed their cash problem through the issuance of more bonds mentioned above. This along with the selling of ships by Carnival and its subsidiaries (Holland America Line has sold four of its ships in august) will provide more than enough cash inflow to help the company survive the pandemic.

Looking towards Carnival’s long-term survival, this will depend on how the cruise sector recovers from the pandemic and the underlying trends that will occur. The Cruise Lines International Association, Inc. (CLIA) predicted that the experience of cruising rather than material items purchased on other types of holiday will drive demand in the future, especially drawing Generation Z consumers. Along with other trends such as Cruising being more ‘instagrammable’ and the increase in popularity of off-peak sailing, Carnival and its competitors look set to have a nice base for growth during the 2020’s and onwards. However, these predictions by the CLIA were made before the pandemic in 2019, so whether they occur will bank on how safe passengers feel in going back to cruising. Whether they stay afloat and profitable will also depend on their ability to pay back bondholders the high yields they offered as a premium for consumers investing in their struggling business.

Definitions

Secured debt: debt backed by collateral, tangible assets, such as property, plant, or equipment. In the event of default, the bondholders are legally entitled to take possession of the pledged assets. Collateral reduces the risk that bondholders will lose money in the event of default since the pledged assets can be sold to recover some or all of the bondholders’ claim (missed coupon payments + face value).

Junior debt: unsecured subordinated debt with lower priority of repayment than secured debt and other unsecured debts (senior debt) in the case of default.

Junk bond (or high-yield bond): debt with low credit rating and below investment grade. They are very risky and have high probability of default. Because of that, investors are compensated with higher interest rates

Current Ratio: The ratio of current assets to current liability. It is an indication of short-term liquidity and shows the ability of a company to pay obligations due within one year.

Generation Z: demographic cohort succeeding millennials. Researchers and media personalities place these people as being born between mid 1990s and mid 2000s

References

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